Belray Market Briefing

Annual Index Reconstitution Effects

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-29T22:43:47-04:00

The bottom table shows the migration effect in the Russell 2000 Index compared to the CRSP 6-10 Index. The Russell 2000, which purports to describe the US small cap stock universe, is reconstituted each year in June. The CRSP 6-10 is a more comprehensive proxy of the smallest five deciles of the market universe, including the smallest stocks. It is rebalanced quarterly and is used for performance analysis and research.

The numbers show that the Russell 2000 does not consistently reflect the composition of the smallest stocks in the market. From 5/31/07 to 6/30/08, the Russell 2000 Index lost exposure to the smallest 10% of stocks by capitalization. Conversely, the CRSP 6-10 Index maintained more consistent exposure to the smallest 10% because it is rebalanced four times a year.

The bottom graph illustrates that the Russell 2000 Index’s exposure to the smallest 10% of stocks has often changed dramatically from month to month, while the CRSP 6-10 Index has maintained more consistent exposure to the smallest stocks.

Small cap index funds typically track the Russell 2000, and time their buying and selling decisions to fit the benchmark’s annual reconstitution. However, by closely tracking an index, an investor tethers his portfolio to an arbitrary standard that shifts over time, resulting in potentially lower diversification and unreliable exposure to the underlying risk factors that drive expected returns.

Commercial indexes attempt to reflect particular asset classes or market segments. However, indexes often do not deliver on their intent. One reason is that most indexes are reconstituted (or redefined) annually. During the year, some securities experience changes in their risk characteristics—for example, a stock might move from small to mid cap, or from value to growth. This “migration” alters an index’s coverage until the next reconstitution date, which may be several months away.

Source: Dimensional Fund Advisors

Warren Buffett's Best Advice

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-19T21:28:31-04:00

Bogle at Yale CEO Summit

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-28T21:16:45-04:00

Dollar Cost Averaging

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-28T20:50:42-04:00

Source: Dimensional Fund Advisors

Identifying Superior Investment Managers

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-28T20:31:13-04:00

Source: Dimensional Fund Advisors

Retirement, Risk, and Return

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-27T22:40:19-04:00

Source: Dimensional Fund Advisors

Pension Funds Shift To Index Funds

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-26T16:25:48-04:00

There have been a number of articles lately about the growing number of large investors who have become dissatisfied with money managers who pick stocks and bonds. These institutions have concluded that active money managers added very little value during the market turmoil over the past year and so, they are shifting to index funds.

This move threatens to cut profits for active asset managers. In general, stock index funds charge less than 0.30% of the money they manage. Active money managers charge fees up to 2% of the money they manage. It looks like they will be managing less money.

“Active managers have not given us the added performance in a down market that we hoped for” says Bill Atwood, executive director of the $ 9 billion Illinois State Board of Investment. His fund moved about $ 400 million to index funds. Recently, Greenwich Associates did a survey and discovered that one in five institutional investors have recently shifted money away from active managers to passive index strategies. That is up from just 4% who expected to make that shift just a year ago.

According to an article written by Graig Karman in the Wall Street Journal, a record number of asset managers will be replaced in the second half of this year. Mellon Transition Management, who helps institutional invertors switch managers, agrees with this analysis. Rather than try to pick winners, many institutional investors are more worried about being stuck with losers, so they are now choosing index funds.

We at Belray Asset Management find this trend interesting because, from the start, we have based our investment strategy entirely on a highly diversified portfolio consisting of index funds.

Active Investing Is a Negative Sum Game

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-10T10:54:43-04:00

Stories of superior performance from "active investing", like market timing or stock picking, are plentiful. Inevitably there is someone at a cocktail party that got things just right while those that are out of step at the moment tend to be quiet.

Over the longer term few professional active managers or individuals trading their own accounts add value. While superior performance can sometimes be achieved, research has shown it is impossible to tell which investors achieve such returns due to superior skill as opposed to luck.

This poses quite a problem for any investor who has selected an active manager or is trying to select investments himself. Take a moment to read this recent article by Eugene Fama and Ken French that addresses the costs active managers place on the US equity markets.

Read the full Fama-French article: Why Active Investing Is a Negative Sum Game

Kind regards, Greg

Economic Speed Limits

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-06-07T10:49:41-04:00

The June 1 Business Week has a terrific article on over-regulation and slow growth by Mohamed A. El-Erian who is the CEO of PIMCO. Over the past past decade or so years we have been through a fast lane experience of high growth (4.5%) and low inflation. This led to the super debt-cycle which ended with the U.S. economy at a total dead-end. The article describes how this led to DDR dynamics, which is the combined forces of De-leveraging, De-globalization and Re-regulation. When home prices crashed, consumption plummeted, banks stopped lending, and cross border activities slowed way down. Then policy makers felt forced into action. Economic behavior changed and the delicate balance moved from the market's invisible hand to the government's fist.

The economy of tomorrow may have a lower "speed limit". The author says to start thinking about growth under 2% and unemployment at 6% or more. The financial system will look more like a utility, burdened with over-regulation that limits volatility. Politics will dominate economics. Just look at what happened to the Chrysler bond holders.

If Mr. El-Erian is right about the lower domestic speed limit, investors may see speedier growth overseas, making their allocations to international and emerging market equities more important then ever. Not that investors should not get carried away. We still believe half of our client's equity allocations should stay in the conservative drivers lanes of the US markets. - Phil

Do you feel lucky?

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-05-29T14:47:39-04:00

I recently heard an interview on Bloomberg Radio with John D. Spooner, money manager and author, and the topic was: 3 questions to ask your financial advisor. The first and third questions below are his, but I changed the middle question to one that is more useful. If your advisor cannot adequately answer the following questions, your financial future is in the hands of an amateur and chance, and success is apparently optional.

1. What is your investment philosophy?
2. How do you drive returns from an investment portfolio?
3. What is you favorite book?

My investment philosophy starts with identifying a client’s goals. These goals are then monetized. It is my job to maximize the opportunity of meeting the monetary portion of a goal.

Once goals are articulated, an investment plan is crafted. Regardless of the level of risk in a portfolio, all capital investments derive their returns from three factors: market timing, security selection, and asset allocation. All three of these factors are utilized in my portfolios.

The final portion of my philosophy involves a feedback examination of both the goals and the portfolio. If the goals or markets change, so must the portfolio. Never are either static.

It has been my experience that the overwhelming majority of financial advisors cannot articulate an investment philosophy. (Hint: An investment philosophy is not: “To manage risk to maximize returns regardless of market conditions.” That is a goal.) Nor do most advisors even understand the basic concept of what drives returns within a portfolio. The later deficiency is not only attributable to professional ignorance, but this fault is exacerbated by technical and policy limitations enforced by their employer.

To understand why this exists, one needs to know who a public corporation serves. Simply, it serves the share holders first, the employees second, and the clients third. Anything that cause liability for a share holder or an employee (or their manager) is counter productive to serving the two primary stakeholders. For example, an investment in a specific stock (security selection), at a specific time (market timing), may be in the best interest of the client. This investment, however, introduces liability to share holders and employees, therefore the client’s interest is trumped.

These liabilities are limited further by restricting the capability of an advisor to perform trades and to select securities. Considerable commissions are charged to discouraged clients from exposing the firm to risk. If an advisor tries to circumvent this risk management technique by discounting a commission, the firm will not pay the advisor for that trade.

The final strike against individual security positions is driven by technical issues. First, very rarely is an advisor allowed discretion within a client’s account (huge liability to the firm). Since the advisor does not have discretion, he must confirm with every single client all security transactions. This could take days to move in or out of a position. Furthermore, the advisor is not provided with an institutional trading platform. Every single order must be placed separately for every client position. This alone makes the task nearly impossible, and it guarantees that the market timing will be better for some clients than others. (Are you first on your advisor’s “call list” when he needs to make a change?)

Instead, advisors are told to develop asset allocations, and to “manage the managers.” This strategy involves trying to drive returns by only utilizing one of the three factors. The result is predictable: market performance, nothing more. Mediocre returns for a mediocre investment philosophy. Add the fees onto this plan, and the performance slips to sub-market.

Advisors are coached by the firm that they cannot compete on performance, therefore they need to maintain customer loyalty through a high level of personal service. Which would you prefer, a high level of friendly service, or the maximum opportunity to meet your financial goals? These do not need to be mutually exclusive, but at a publicly-traded wirehouse the performance aspect is excluded.

From the firm’s aspect, not dealing with performance issues has the added bonus of freeing up their advisors to be “asset gathers.” A scalable, vanilla investment procedure frees up the advisor to do their “real” job: sales. Indeed, advisors are given bonuses for enrolling new assets. Achievement levels (and advisor pay) within a firm are in no way tied to performance. They are tied to two things. One, how much money did you bring in this year? Two, how much money did you make for the firm?

Wirehouse advisors with the best intentions are working within a system that is designed to maximize profits for shareholders, while minimizing risk for the firm. Clients’ goals are not a concern. Firms will argue otherwise, but their incentive system for their representatives exposes, in crystal clarity, what they say versus what they do.

When someone asks me what my favorite book is, a few come to mind. The first is Atlas Shrugged, by Ayn Rand. Great Expectations, Wuthering Heights, the Great Gatsby, Moby Dick, and Lord of the Flies also make my short-list. If you’re interested, I can tell you why I appreciate each one of these.

To know why this question is applicable one needs to understand the barriers to entry in being a financial advisor. The barrier is: the FINRA Series 7 test. That’s it—nothing more. This is a 260 question test, and a 70% correct rate is required to pass. The test can be taken indefinitely, until a passing score is achieved. It is my guess that the average elementary school student could pass this test with less studying than is spent for the SAT.

Knowing that virtually anyone can be a financial advisor, it is important to know what experiences and level of mental acumen your advisor brings to the table. Knowing their favorite books will give you insight into the person that may not be reflected on a resume. If their favorite book is the latest pop-novel, you may wish to further exam the depth of the person with whom you trust your future.

Don’t be afraid to ask your current advisor these three questions. These questions are very easy to answer, and they should be non-confrontational. If the answers are hedged, inarticulate, or dodged, then you have a problem. That’s critical to acknowledge: the advisor does not have a problem—you do.

Extreme Stock Returns are Common

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-05-18T22:24:15-04:00

As I speak with clients, I am finding they are breathing sighs of relief. Unfortunately, part of my job is reminding clients that while they may feel good now, the stock market has and always will be a bumpy road.

Investors will look back upon 2008 and discount it as a one-off situation unlikely to repeat. The reality is that what happened last year is extremely likely to happen again. It is simply not likely to happen frequently.

Extreme stock returns are common. Thankfully, since the 1800's, extreme positives returns have outnumbered extreme negative returns. As our economy stumbles towards a recovery, expect to see continued extreme stock price movements, both positive and negative. Just remember that if you avoid the risks of the stock market you will also avoid its rewards.

Click for an article on extreme returns by Professors Fama and French

You’re Gonna Like the Way This Looks

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-05-15T20:41:18-04:00

A stock that is squarely on my RADAR is Men’s Wearhouse (No, I did not misspell it—they are witty.) You probably know this company from the founder, George Zimmer, and his ubiquitous commercials: “You’re gonna like the way you look. I guarantee it.” Well, there is something about the look of Men’s Wearhouse that I like.

Men’s Wearhouse (NYSE: MW) is a retail clothier that targets middle class men as its customers. It has a mix of house label and, increasingly, third party clothing (e.g. Calvin Klein (Ticker: PVH)), that is primarily business and business casual. In addition to suits, they market higher margin items like shoes, belts, and shirts.

Part of the retail execution plan includes a customer “experience.” Here’s how this works. Customer Smith walks into a Men’s Wearhouse store, because he plans on buying a new suit. He’s greeted by a trained salesman (“wardrobe consultant”) who qualifies his needs, wants, and means, who then guides him to an appropriate selection. When a suit is selected, and measurements are made, the sale is not over—it has just begun. The next step is to display this suit with a variety of shirts and other necessary accoutrements. You’re sold on the idea that you do not need a new suit, rather, you need a new, professional image—the suit is foundation of that image, but not entirety. By the time Customer Smith leaves the store he has not only bought a suit, he has purchased a few ties, a new pair of shoes, and a belt to match. The customer walks away feeling like a million bucks, because he was waited on hand-and-feet, and Men’s Wearhouse rings the register. That’s a client experienced pulled right from the classic playbook of Nordstrom’s (Ticker: JWN) (a shoe store turned legendary-customer-service department store).

Here are a couple of important points from that story. Unlike a stroll through Spencer Gifts, people do not walk through the doors at Men’s Wearhouse to browse, they are there for a reason. The service is solid and personal, the customer walks out without buyers regret. They like the way they look, and they tell their friends.

Alright, none of that is rocket science, but as an uncle of mine recently mentioned to me: “Suits are no longer mandatory for business. I used to wear a coat and tie every day, but now I rarely even wear a tie.” It is true that semi-formal has largely fallen out of vogue in many areas of business, but the need for having business attire on-hand has not. Let’s take a look at an example.

If someone is an investment banker in Manhattan, they probably have a closet full of suits from stores like Barney’s, Bergdorf, and Bloomingdale’s (Ticker: M). They don’t need anything in terms of business wear. Contrast this with the sales manager of the local Pontiac dealer. He now finds himself on the job-interview circuit, and a suit is mandatory here.—that is, it’s mandatory if he wants a shot at winning a job when it is a 10% unemployment environment. He is not about to drop $4,000 for a Brioni. He needs someone that can put together an impactful impression at an affordable price. Those are our friends from Houston.

I don’t consider the previous scenario a stretch, but some clients don’t agree with me. Fair enough, but this organization is not a one-trick-pony. A seemingly obscure fact is that Men’s Wearhouse operates the largest formalwear operation in the United States. This empire was built through a few, intelligent acquisitions, but at this point the tux rentals are largely integrated into retail clothing stores to maximize cross traffic and selling. I don’t buy Men’s Wearhouse contention that Tuxedo rentals are countercyclical to clothing sales, but I do contend that a formal is not discretionary if you are attending a prom or invited to take part in a wedding party.

Before I write their 2008 Annual Report here, I need to get to some other points that I think will help this stock performance in the near time frame.

1) Deflation has likely squeezed profit margins, but this will be offset by lower production costs.
2) In this industry you can make it up with volume. We have witnessed this recently with a direct competitor of MW: Joseph A Bank (Ticker: JOSB).
3) JC Penney just hit their target, today. I think Men’s Wearhouse will also, but a lot of people do not agree with me.

That last point is important. As of this writing, approximately 15% of the shares float is sold short. What that means is that people have borrowed 15% of the available MW stock and sold it. 15% is significant. They are hoping the stock will drop, at which point they will purchase at the low price. (It’s buying low and selling high, except in reverse). If they are wrong about Men’s Wearhouse missing its target, then the stock can move against them, i.e. the stock will rise, and they will have to buy high after selling low. As they are trying to buy the stock to “cover” their short position, they will push the price higher. Think about that for one for a moment. Their need to close the position requires them to buy. Their purchase pushes the price higher. The weaker shorts will get out quickly, putting a “short squeeze” on the more determined. The more determined will really take it in the shorts, as the price runs away from them upwards. If they are right, they cannot apply further downward pressure on the stock, because they have already sold. Their negative price impact has already been applied.

Is a short squeeze possible here? Absolutely. Although, I would not invest in the company for strictly that reason, the potential for that is merely gravy. MW is well managed company, properly positioned for a frugal economy, with a product people need. Some of my clients currently own Men’s Wearhouse, we will consider adding additional positions to clients accounts as the 10 June earnings announcement approaches.

As always, please post your comments below, and I will personally answer them.

Disclosure: Some of our clients hold positions in ticker MW, No clients hold positions in JCP, JOSB, M, PVH, JWN. I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Time to bulk up?

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-05-13T16:02:38-04:00

When the bottom dropped out of the economy one of the hardest hit sectors was the dry bulk shippers. What are dry bulk shippers, why did they experience such a sell-off, and how and when will they recover? Furthermore, what are the possible upsides and losses associated with investing in this sector?

Dry bulk shippers are exactly as their title implies. These are companies that ship dry goods: large bulk like iron ore, grains, and coal; and small bulk like sugar, cement, and fertilizer. It’s a necessary cog in global trade, but it’s often overlooked by its more glamorous brother, oil tankers.

As a national economy develops it has a need for infrastructure, food, other raw materials, and consumer goods. If these needs cannot be met locally, or they can be met more efficiently from a foreign source, then the necessary catalyst for international trade is present. If the economies are not connected via a robust rail system, or if the distance is vast, then the only feasible way to deliver the goods is via oceanic shipping. This seems obvious to us today, but for many centuries the Silk Road was strictly land based. It wasn’t until 1497, when the Portuguese explorer Vasco de Gama rounded the Cape of Good Hope on the tip of Africa, that a functional, efficient, and complete sea-based shipping route was finally established between the East and the West. Not coincidentally, this achievement was reasonable for thrusting Portugal into the world as preeminent, global power.

Reviewing this original demand for sea trade elucidates why it still plays a vital role today. The East is still in a rapidly developing phase; look at Korea and China for direct evidence of this, and their growth demands raw materials from Australia, the Americas, and Europe. Silk has been replaced by flat-panel LCDs, automobiles, and semiconductors. As since the 15th Century, these goods are transported by dry bulk shippers.

As the global economy grinded down in 2008, so did the demand for shipping. The index used to track the rates (demand) for shipping is the Baltic Dry Index (BDI). This index is maintained by the Baltic Exchange, and a view of this index will show you what happened to shipping demand around August of 2008. (This is a better chart, but you will need to adjust the view to 1 year using the button above the top-right corner of the chart.) If you are curious about what a shipping route is, this document provides some fascinating information on the global shipping routes that comprise the BDI. This commerce is occurring daily, but rarely do we contemplate the role it plays in our lives.

You can see that the drop was sudden and spectacular. It was worse than any of the major stock indices, shedding over 90% of its value in 6 months. Interestingly enough, this drop happened before the major drop in global equities—a fact we can use to our future advantage. What exactly caused this remarkable reversal?

The first cause is obvious, there was a decrease in global shipping demand. Shippers attempted to protect profit margins by slowing shipping speeds to lower their fuel costs. This attempt was insignificant, because demand dropped so quickly, in particular the demand from China for raw materials. Direct proof of that can be seen by observing what happened with basic material demand, in particular, the prices of industrial metals copper and steel (you can look at the steel company Posco, or the copper miner Freeport McMoran, to see that decline reflected in their prices). Hopefully I’m illustrating the correlation among commodity prices, equities, and shipping rates. They are all tied together, with the BDI being a proxy for international trade and the health of the global economy.

Another major problem struck the shipping industry, and this was the ailing credit market. Since the Hammurabi era of Babylon, letters of credit have been used to ensure the viability of commerce. When someone makes a shipment, they want an assurance that the receiving party, thousands of miles away, will have the means to pay. Two of the largest issuers of letter of credit for the shipping industry were Barclay’s Capital (located near the Baltic Exchange in London), and Lehman Brothers. Just as the bottom was dropping out of the BDI, Lehman went bankrupt due to excessive credit risk. Meanwhile, Barclay’s is under extreme pressure, as the UK is in a fury over the health (correctly perceived as very bad) of their own financial system.

Some shippers had ordered new hardware (with names like Capesize, Panamax, Supramax, and Handysize) at exactly the wrong time. It was the peak of global demand for their services, and the peak of ship-building material costs. Both would drop, as would US Shipping from the rank of non-defunct companies (they declared bankruptcy last month). The Danish shipping company Atlas shipping beat them to bankruptcy in December of 2008.

That is the abbreviated history of global shipping, why they suffered this past year, and what sort of factors are required to revitalize this industry. In short, a resurgence of global trade will directly, positively impact this industry. Furthermore, the BDI tends to be a leading indicator to global recovery. Companies may not be permitted to reveal their results before announcement dates, but the BDI can give us a very real indication of what people are paying to ship. As this index rises, so is the demand for oceanic shipping (it is a price of transport index—it does not lie).

So how do we invest in this index if the timing is correct? One way is through an exchange traded fund that is comprised of several shipping companies: the Claymore/Delta Global Shipping ETF [NYSE: SEA]. This is not my preferred method, because this ETF has among it some dogs in it I would rather not own. Alternatively, I prefer individual companies in this space, for example, Paragon Shipping [NASDAQ: PRGN].

Why would one ever consider investing in such a volatile industry? Simple: the opportunity for large, outsized gains. It will not be possible for a global economy to recover without recovery of global trade, ergo, global shipping.

This brings us back to a point we touched briefly before. The primary expenses for shipping are fixed. As noted, there was an attempt to lower expenses by slowing shipping, but this largely futile. Fuel, crews, and maintenance—those are the costs. For ease of illustration, let’s suppose those costs amount to $100 per 100 nautical miles. Furthermore, let’s say that the cost of shipping goods is $110/100 nautical miles. This is a profit margin of 10%. If the cost to ship (via increased demand) goes to $154, that is a 40% increase in cost. The profit margin goes from 10% to 54%. Notice the 40% increase in cost to ship, but the 44% increase in profit margin. This is due to fixed costs. The costs are not strictly fixed (the price of fuel can increase), but they are passed to the customer. It was this same phenomena, in reverse, that forced many ships to not even accept cargo this past year: the profit margin was near zero, and certain costs could not be eliminated. The point to this discussion on fixed costs: As the BDI increases, the profitability of shipping companies will increase more quickly.

In summary:

1) Global shippers were the hardest hit industry.
2) The economy cannot fully recover without global shippers.
3) The profitability of shippers does not recover in a linear fashion to recovery of the BDI, it does so at a multiple greater than one.
4) Shipping recovery will happen before a global economic recovery (leading indicator).
5) The sector is extremely volatile, but the opportunities for patient investors are great.

Disclosure: Some clients currently have a position in Paragon Shipping. No clients hold a position in the Claymore/Delta Global Shipping Index. I have strong opinions so be sure to read a few. As always, please post your comments below, and I will personally answer them. I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Income Strategies with Closed End Funds

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-05-04T14:23:39-04:00

In every portfolio I have included the Calamos Strategic Total Return Fund (NYSE: CSQ) and the Western Asset Managed High Income Fund (NYSE: MHY). These are both closed end funds.

The first is the Calamos Strategic Total Return Fund (NYSE: CSQ). This fund invests in common shares of dividend stocks, convertible securities, and high yield bonds. Currently it is available at a 14% discount to NAV.

Here is how CSQ did the past month.
Here is how CSQ did the past year.

As you can see, since we have started investing in this fund it has gained over 20%, versus approximately 13% for the S&P 500. If you look at how well it did over the past year, it is a whole different picture. This fund is leveraged, which means that it borrows money to make additional investments. That leverage is what hurt it so badly this past year, but is making it so attractive right now.

CSQ pays a dividend monthly, which is an annualized rate of 13.74%. This distribution is being reinvested into the fund, because the fund has a very attractive reinvestment policy. If the fund is trading at a discount, the dividend is reinvested at the discount. If it is trading at a premium, the dividend is reinvested at the premium minus 5% or the NAV, whichever is greater. Unless it is trading exactly at NAV, our reinvested dividends will purchase additional shares at a discount to either NAV or the market.

The second closed end fund we are investing in is the Western Asset Managed High Income Fund (NYSE: MHY). This fund concentrates on high yield bonds.

Here is how MHY did the past month.
Here is how MHY did the past year.

As you can see, this fund has outperformed the major stock indices this past year. It is not leveraged, and bonds, even high yielders, are higher on the capital structure than equities.

It also pays a monthly dividend, which is 11.95% annualized. When we purchased this fund it was trading at a discount of around -4% to NAV. It is currently trading at a premium of 4.19%. That helps explain how in the past month it has appreciated by 12.88%, versus the S&P 500 gain of 8.18%. This fund is a bit rare in the high yield closed end universe; since it is not leveraged. When concentrating strictly on an asset class like high yield bonds I do not prefer leverage. This fund does not have an ingenuous reinvestment plan, so we are taking the dividends as cash.

These two investments have many smart attributes that merit inclusion in the portfolio. First, they are growing capital, and they are outpacing the broad stock market in doing so.

Second, they have a strong cash flow. With the Calamos fund we are reinvesting the dividend due to its composition of common stocks and discount reinvestment program. With the Western Asset fund we are “clipping the coupon” and taking the cash to use for other investments.

Third, these are investments that can do well if the market turns down. The last 6 weeks have been incredible for stocks, but I don’t expect it to last. If we do see a sell-off, the Calamos fund will take a hit, due to its leverage and its common stock components. On the positive side, its convertibles and bonds will help buoy it, as will its large cash distribution. That, combined with its discount reinvestment plan, will help keep us above water with this investment. The Western Asset fund will likely continue to do as it has throughout this market turmoil – outperform the stock market, and do so while yielding close to 12%.

Under normal circumstances, these two investments could easily comprise a large part of a portfolio. The reasons they do not are:

1) Investors are in need of rebuilding capital, and in the long run the best wealth generators are equities.
2) The high volatility has made trading certain securities lucrative. These opportunities do not come often, and we need to capitalize on them.
3) Terrible yield on senior bonds has brought money to these investments.

The inclusion of these two is the result of following scores of closed end funds. For various reasons, whether it is leverage or too much risk, the others were not chosen. Let me provide an example of a fund we did not invest in, and the reasons why this was avoided.

Here is a perfect example of a fund in which we did NOT invest: the PIMCO Floating Rate Strategy Fund. We do invest in floating rate funds (which you will hear about next week), but I purposely steered clear of this one, despite its high yield and marquis name (PIMCO is considered by many to be the king of bond investments). There were a couple key issues with this fund.

First, by January this fund had switched from investing in senior floating rate notes, and had invested approximately 50% of its assets in corporate bonds. They did not broadcast this, but it was obvious in the fine print of their holdings for anyone that took the time to read it. The corporate bonds they invested in were primarily the financial and automotive companies (big problem number 2).

The last problem with this fund is that it has had to deleverage in the worst of environments. Many floating rate funds had to do this, and cut their dividend, but PIMCO had ignored its investing mandate and cast its lots with corporate bonds.

Was this just an example of a good fund caught in a bad environment? No, and here’s why. The two floating rate investments that we use are the Riversource Floating Rate fund and the First Trust/Four Corners SRFI Fund II. Click on this link to see how they fared since late January – the time we began investing in them.

As you can see, there is definitely a science to selecting these investments, and they are not all created, nor managed, equally.

I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Income and Inflation

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-04-18T21:14:38-04:00

At some point you may need to collect income from your investment portfolio. If you're like most people, this income will need to last a long time and keep up with inflation. As portfolio managers, it's our job to help investors navigate this challenge.

Our research has concluded that a mix of high dividend paying stocks and short term bonds is a great asset mix to address this challenge. If the topic income and inflation interests you, you may enjoy this presentation on our new conservative income strategy: Click Here for Interactive Presentation

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Why We Cheat

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-04-14T20:03:26-04:00

If the speed limit is 55 mph and everyone on the highway is going 65 mph most of us would find it acceptable to also go 65 mph.

Unfortunately our society got comfortable going 100 mph (in terms of the use of credit and leverage). As a result there are many people to blame and few people willing to take responsibility.

I found this video from the TED conference helpful by exploring why we got into this credit mess. The findings of the speaker's study are not what you would expect.

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Fiduciary Failure

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-04-13T21:51:19-04:00

Here is a great example of how active managers (stock pickers) have let down investors during this recent crisis. Over the weekend the NY Times published an article highlighting the fiduciary failure of active (stock picking) institutional money managers.

The father of index investing and founder of Vanguard Funds, John Bogle, believes these managers "allowed the nation’s financial companies to amass enormous risks on their balance sheets and pay gigantic compensation based on false profits." He continued, "Given their forbearance as corporate citizens, these managers arguably played a major role in allowing the managers of our public corporations to exploit the advantages of their own agency.”

He contends the fiduciary duties given to these managers have been misplaced. In his view, these managers have failed their clients, hedge fund shareholders, mutual fund shareholders, pension beneficiaries and long-term investors. Instead of serving their clients, these managers have served themselves.

It's an important and enlightening read: Click here to read the full article.

Warm Regards, Greg

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

The Risk of Market Timing

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-03-27T13:34:28-04:00

If after the recent rally in the US stock market you find yourself wanting to buy so you don't miss the rest of the rally, or wanting to sell so you don't lose what you've gained back, you're not alone. One of the first questions we are often asked is whether someone should be in or out of the market. The very first thing we try to teach clients is that timing the market is impossible.

We want our clients to understand the most important rule of investing in the capital markets: to have an opportunity to receive the expected return of the stock market, investors must also be willing to accept its risks. If investors seek to avoid the stock market's risks, they will also likely avoid its expect returns. Worse, they will continue to drive themselves crazy trying to time the impossible.

On paper, market timing offers a seductive prospect: by predicting market direction ahead of time, an investor might capture only the best-performing days and avoid the worst. The reality is much less appealing. For example, the worst market day since 1970 occurred on October 19, 1987—just two days before the best day of the period. An investor who avoided the worst day would have earned a 10.10% annualized return, but missing the best day would have reduced the return to 9.18%. Dating back to the 1800's, the upward movements of the US market have historically been much greater then the downward movements. Therefore, investors have been rewarded for staying in their seats and waiting for the upward movements.

Click on the image below to enlarge the slide.

As you can see, large gains may come in quick, unpredictable surges. Trying to forecast which days or weeks will yield good or bad returns is a guessing game that can prove costly for investors. Below is an analysis offering further insight into the potential consequences of both successful and failed market timing.

Click on the image below to enlarge the slide.

No adviser can predict the future and if you have previously had bad investment experiences it may be because you've had too few bonds and little cash in your portfolio to suit your risk tolerance. Contrary to most of Wall Street, we believe your cash, bond and stock allocations should not change based on your market outlook, but only change according to your personal situation. I find that once a client permanently commits to having adequate cash and bonds in his or her portfolio, he or she can relax about the stock side of their portfolio.

Gregory H. Skidmore
President and Chief Investment Officer

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

1871-Present | Recoveries from 40% corrections

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-01-09T08:24:55-05:00

There have been only four corrections greater than 40% since 1871(five counting the current one). Below is an analysis of those four severe corrections and a look at performance of the S&P 500 from the approximate bottom of the correction.

The annual return of the S&P 500 since 1871 has been roughly 10%. However, after a 40% correction, like the one we are experiencing now, the index has returned around 15% annually.

By looking at the data below and using the tool on the New York Time's website, you will have a better understanding of how long it may take for your stock portfolio to recover.

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

2008 Returns for individual countries

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-01-06T12:41:32-05:00

As we all know it is has been an ugly year for equity markets around the globe. Below are country specific stock market returns for 2008. While some of the emerging market countries are still showing growth in their economies, the vast majority of the globe is seeing a slowdown in growth and in some cases (like the US) there is negative growth. We believe that the equity markets will start to recover 6 to 9 months ahead of each respective economy. For clients of our firm, we continue to allocate a global equity position.

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

11 Year Asset Class Performance Matrix

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2009-01-02T08:47:02-05:00

CLICK ON THE IMAGE BELOW - To view our 11 year asset class performance matrix updated for 2008.

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Foreign investment managers find U.S. companies attractive.

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-12-10T08:18:40-05:00

I was reading Pensions and Investments this morning and found an interesting article that discusses how global investors are finding themselves allocating to the U.S. Investments.
What's particularly interesting is that foreign investment managers are finding specific U.S. companies (public and private alike) particularly attractive. So they are finding their shift to be a result of where they see value on a company level rather then trying to make a wide spread call on the U.S. economy.
If you want to read the entire article you can do so here: Pensions and Investments.
Warm Regards, Greg
Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Endowment ETF Insight: Harvard, MIT and Yale

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-12-02T00:40:56-05:00

The endowments of Harvard, MIT, and Yale all utilize Index ETFs as a part of their investment strategies. In reviewing their 2008 third quarter SEC filings it was interesting to see a split in their indexing strategies.

Harvard increased its allocations to Emerging Markets, US Small Cap Stocks (IWM), and China (FXI). It decreased its allocation to Brazil (EWZ).

MIT increased its allocation to Emerging Market Stocks (EEM) and US Stocks (SPY). It cut its Developed International Stock (EFA) exposure in half.

Yale increased its allocation to Developed International Stocks and US Small Cap Stocks. It decreased its allocation to Emerging Markets Stocks.

It has been well documented that endowments are faced with capital calls for their private equity holdings and ETFs provide some of the easiest liquidity for serving those capital calls. We wonder if that's led to the sale of some of their positions.

We are also not surprised to see the reallocation of capital to Emerging Market Stocks. These markets experienced some of the most ferocious selloffs, and it looks like Harvard and MIT wanted to take advantage of these declines.

The move into US Small Cap Stocks comes as no surprise either. We believe institutions are positioning their portfolios for an economic recovery and historically US Small Cap Stocks outperform other asset classes as the economy starts to improve.

Disclosure: The author’s firm has positions in SPY, EEM, EFA

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

November: Best and Worst Asset Classes

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-11-15T23:41:43-05:00

What asset classes are winning in 2008 as of Saturday, November 15th?
1) +7.07% - Domestic Intermediate Treasuries (ITE)
2) -1.78% - Tax Free Municipal Bonds (MUB)
3) -5.00% - Domestic Treasury Inflation Protect Securities (TIPS)

What asset classes are losing in 2008 as of Saturday, November 15th?
1) -54.66% Emerging Market Equity (EEM)
2) -59.82% International Listed Private Equity (PFP)
3) -64.95% Domestic Listed Private Equity (PSP)

How are the broad markets as of Wednesday, November 15th?
Domestic: Stocks (SPY): -39.21% and Bonds (AGG): +.50%
International: Stocks (EFA): -46.64% and Bonds (BWX): -5.00%
Emerging Market: Stocks (EEM): -54.66% and Bonds (EMB): -14.82%

Our Comments: The US stock market continues to be one of the best performing markets around the globe. It’s sad to say, but down 39% is actually good compared to the global equity markets. The big surprise in the last few months is how correlated all asset classes have become. To be up this year you really had to be in cash, treasuries or short the market. Despite all the infomercials on TV even gold is not up this year. Stay invested and stay diversified.

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Important lecture by head of Yale's Endowment

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-11-07T07:34:22-05:00

David Swensen has been the investment manager of Yale's Endowment since 1985 and is known as one of the best investors of our time. He recently was a guest lecturer at one of Yale's economics classes and the lecture is posted online.

Our investment process is largely based on the "Yale Model" of investing and I believe you will find his thoughts reassuring and educational.

Click here to watch Swensen's lecture at Yale.
Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

Glance into ETF index holdings of Harvard, MIT and Yale Endowments.

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-10-30T12:34:49-04:00

The endowments of Harvard, MIT, and Yale all utilize Index ETFs as a part of their investment strategies. Reviewing their top ETF holdings provides insight into their investment strategy.

It seems that heading into this crisis, they had significant allocations to Emerging Market Equity Indexes. It will be interesting to review their public filings at year end. I would not be surprised to see them adding to their US Equity positions as the US markets declined in September and October.

Harvard Endowment

MIT Endowment

Yale Endowment

Disclosures: I have strong opinions so be sure to read a few important disclosures regarding this and other articles.

How retirees can protect their income needs.

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-10-28T23:43:19-04:00

How can retirees meet their income needs and manage current market risks?
A Barbell portfolio is comprised of 50% very safe assets and 50% very risky assets. It did surprisingly well during the 1929 crash and also during the recovery from the 1974 crash. While it's had mediocre long-term performance, it does provide substantial benefits to retirees during extreme market environments like the ones we are seeing today.

What if we're halfway through a 1929 crash?
As you can see, changing to a Barbell portfolio in the middle of the 1929 crash safely funded an annual $50,000 distribution and still exposed the portfolio to enough equity risk so that it was able to recover when the markets rebounded.

The portfolio illustrated is constructed out of three indexes. 10% 90 day treasuries, 40% intermediate government bonds and 50% small cap stocks. It assumes a $1,000,000 initial investment, is rebalanced annually, includes our maximum fee of 1.50% and an annual withdrawal of $50,000.

What if it's 1974 and we're about to recover?
The Barbell portfolio still did surprisingly well during the recovery period after the 1974 crash. It even outpaced the S&P 500 shown by the light blue line above.

The portfolio illustrated is constructed out of three indexes. 10% 90 day treasuries, 40% intermediate government bonds and 50% small cap stocks. It assumes a $1,000,000 initial investment, is rebalanced annually, includes our maximum fee of 1.50% and an annual withdrawal of $50,000.

Why did this portfolio do so well in tough times?
There are two main reasons this portfolio has performed well during extreme market conditions:

First, the government bonds were able fund the income distributions.
Second, the small cap stock exposure provides a high level of market risk. Fortunately small cap investors have historically been rewarded for this risk.

During these times we believe it is important to fund your liabilities (income needs), while keeping as much market exposure as possible. A Barbell portfolio may provide retirees with a way to accomplish this goal.

Comparing 1929 to 2000

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-10-25T09:33:18-04:00

We understand how tough it is to watch your portfolio go down amidst this crisis. Our firm was founded by a group of families and we invest side by side with our clients. We're all experiencing a very difficult situation together and, like you, we look forward to its end. In the mean time we must remain disciplined and diversified. The following analysis exemplifies how the current events compare and contrast with those of the past.

First, let's look at the roaring 20's and the 2000 tech bubble. Why is this analysis relevant today? The current bear market is remarkably similar to the sell-off that occurred from 1937 to 1938. In short, if 2008 is our version of 1937, this could could amount to one very bad year followed by a year of good returns.

The technology gains seen in the 1920’s and the euphoria after the end of World War I lead to an extremely speculative market that crashed in 1929. In similar fashion, the technology gains seen in the 1990’s and the euphoria after the end of the Cold War lead to an extremely speculative market that crashed with the bursting of the tech bubble.

Today we are facing a financial system that has outgrown a regulatory system created in the 1930’s. The regulation that was enacted in the 1930’s was critical to restoring market order and confidence. The same holds true today. Over the next few years we will see our regulatory and political leaders enact a series of new regulations that will bring our current rules and regulations up to date.

We saw the worst equity erosions from 2000 to 2002, which was very similar to the equity erosion from 1929 to 1931. In 1937 the S&P 500 fell 36%. We believe 2008 may be our version of 1937, which will hopefully amount to one year of poor market performance.

The following document shows how the market moved through the periods discussed (1929-1947 and 1998-present) and pinpoints important events along the way. For those of you who are not visual thinkers you might find the following document a bit confusing Click Here to see our work.

In doing our research we found that we're not the only one's with this belief. If you’d like to read a detailed comparison: Click Here

Shedding light on downturns and recoveries.

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-10-15T09:24:35-04:00

I wanted to reach out given today's extraordinary events. Let me reassure you that although we saw almost all asset classes fall today, we feel this panic will not last for long.

There have been many U.S. equity market downturns over time with varying levels of severity. The most severe downturn marked the start of the Great Depression, where stocks lost over 80% of their value. However, a diversified portfolio of 60% US stocks and 40% US bonds would have declined much less (about 50%).

In the 70's we witnessed another violent market environment. Again, diversification provided important downside protection that you can see in the graph below.

Diversified portfolio: 35% stocks, 40% bonds, 25% Treasury bills. Hypothetical value of $1,000 invested at the beginning of January 1973 and July 2000, respectively. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index. © 2008 Morningstar, Inc. All rights reserved. 3/1/2008

Thankfully we now have easy access to invest in global markets and this provides additional diversification benefits. When stocks lost 44.7% of their value during the 2000 bear market, even a basic globally diversified portfolio of 10% Real Estate, 50% Global Equities and 40% Global Fixed income would have only lost about 15%.

As an investor, remember this: in moments of panic asset classes can become correlated and the benefits of diversification tend to be minimized. The two key words in this environment are moment and panic, because we are in a moment of panic. Panic does not last forever. As the panic subsides, the benefits of diversification will reappear. In the past, diversified investors who have stayed invested have been the first to benefit. Inevitably, the least expected asset class leads the charge out of the bottom and rewards those who chose to broadly allocate.

Let me leave you with a bit of hope. CLICK HERE TO DOWNLOAD a series of charts that shows US market declines and recoveries. You can also CLICK HERE TO DOWNLOAD a chart that shows how the US markets have behaved after previous financial crises. While the financial system is facing challenges never seen before, we feel strongly that the outcome will be the same as it has been in the past. A market recovery is inevitable and it will come sooner then we all think.

Individual investors have refused to globalize.

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-08-23T13:35:54-04:00

Retail investors’ behavior is not reflective of the current global landscape. According to Hewitt Associates’ 401k data for 2007, retail investors were only allocating 14% of their equity portfolios to international investments. This contrasts starkly with the current US portion of global market cap and global GDP. Unlike retail investors, institutional investment activity clearly reflects awareness of the rapid expansion occurring outside the US.

I heard Paul Wolfowitz, former head of the World Bank, lecture on this topic several years ago. At the time, Mr. Wolfowitz pointed out that in 25 years the US portion of global market cap would shrink from roughly 50% to 25%. He also outlined that this trend began to accelerate in the 1970s (at that time US markets made up 66% of global market cap). What troubles me is that institutional investors like Harvard and CalPERS have increasingly moved their equity allocations in line with this global market cap shift. Unfortunately, individual investors who are increasingly more responsible for their own investment decisions (as DC plans overtake DB plans) are showing no signs of adjusting to this trend. This could prove to be a costly mistake.

According to the MSCI Blue Book, in 1970 the US public equity markets made up of 66% of global market cap. We recently ran a simulation using S&P 500 (SPY), MSCI EAFE (EFA) and MSCI EM (EM) Indexes to test how investors would fair if they had kept pace with globalization. We began the simulation in 1970 with 60% invested in the S&P 500 and 40% in the MSCI EAFA index. In 1988 we shifted the portfolio to be 40% the S&P 500, 40% MSCI EAFA and 20% the MSCI EM index to reflect the shrinking global landscape. Rebalancing annually, this global portfolio averaged a return of 11.71% vs. 10.50% for the S&P 500 over the same period.

The case for retail investors to move to a global portfolio is a case for improving their returns. Since 1970 the rate of real GDP growth has slowed in the US. This is also reflected by a US public equity market that has seen its growth rate slow post-1970. This is exactly why institutions are increasingly moving toward global equity mandates. The risk to US retail investors is that they may see investment returns significantly below previous generations. This does not bode well for those investing for retirement today.

Disclosure: The author’s firm has positions in SPY, EFA, and EEM.

August: Best and Worst Asset Classes of 2008

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-08-13T11:49:02-04:00

What asset classes are winning in 2008 as of Wednesday, August 13th?
1) +15.45% - Biotechnology (XBI)
2) +14.77% - Commodities (GSG)
3) -0.66% - Domestic Real Estate Investment Trusts (RWR)

What asset classes are losing in 2008 as of Wednesday, August 13th?
1) -21.16% International Real Estate (RWX)
2) -20.73% Domestic Listed Private Equity (PSP)
3) -19.39% Emerging Markets (EEM)

How are the broad markets as of Wednesday, August 13th?
Domestic: Stocks (SPY): -12.06% and Bonds (AGG): -1.22%
International: Stocks (EFA): -18.69% and Bonds (BWX): +0.20%
Emerging Market: Stocks (EEM): -19.39% and Bonds (PCY): -7.75%

Our Comments: An interesting trend has emerged within the markets in the last few weeks. We're finally seeing some strength from the dollar and weakness in commodities. This trend change is matched by a strengthening of domestic stocks and a dramatic decline of the foreign stock markets.

Most importantly in our minds we have seen great strength from Micro Cap. This may be signaling that the US markets are out of the woods. We are well aware that things are looking better for the domestic markets.

While the US economy is facing significant challenges in some industries not all is doom and gloom. We must always remember that the markets are a leading indicator and they seem to be indicating things will begin to improve.

Stock pickers are dead

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-08-06T22:01:13-04:00

More evidence of the shift towards indexing vs. active management (stock pickers) appeared today as the Massachusetts State Pension Fund moved 2 billion out of Legg Mason active mangers to indexing strategies. Eventually they will be moving all domestic equity exposure to indexing strategies. This was reported on Bloomberg today (click to read article).

Even more incredible, there was a study released that shows only 0.6% of active managers exhibited truly positive alphas over the 1975 to 2006 period (click to read study). We believe strongly in the benefits of Indexing, especially for individual investors. The odds of successfully picking stocks and the odds of picking an active manager that will outperform their relative benchmark is incredibly low.

Managing bank failure risk.

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-07-14T13:36:19-04:00

It’s scary to think about, but I've had a few people ask me about the strength of their banks and if their cash was safe. Am I personally worried about mass bank failures? No, not at all. We are in the business of managing risk and therefore without trying to scare anyone, I thought it would be helpful to address ways to limit your risk in the event of a bank failure. What I am telling most clients is that if you have over $100,000 in cash equivalents at one bank, consider putting the rest into Treasury Bills. Read the following quote taken from the FDIC website:

"Customers who purchase T-bills at banks that later fail become concerned because they think their actual Treasury securities were kept at the failed bank. In fact, in most cases banks purchase T-bills via book entry, meaning that there is an accounting entry maintained electronically on the records of the Treasury Department; no engraved certificates are issued. Treasury securities belong to the customer; the bank is merely acting as custodian.

Customers who hold Treasury securities purchased through a bank that later fails can request a document from the acquiring bank (or from the FDIC if there is no acquirer) showing proof of ownership and redeem the security at the nearest Federal Reserve Bank. Or, customers can wait for the security to reach its maturity date and receive a check from the acquiring institution, which may automatically become the new custodian of the failed bank's T-bill customer list (or from the FDIC acting as receiver for the failed bank when there is no acquirer)".

It’s not time to panic, but it is time to take a step back and evaluate your positioning. What I would suggest is that you take note of how your money is positioned so you can evaluate the potential risks. Take a look at how you hold your cash, the stability of your bank and your needs for the cash you have in savings. If you have any questions please let me know.

Also be sure to visit this link to the FDIC website. It explains how their insurance works in greater detail: Click Here

Important Disclosure

Deals harder to come by, but the money keep on pouring in....

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2007-10-08T16:03:44-04:00

While venture capital fundraising is off this year (down to 18.8 form 21.3 billion), private equity money keeps pouring in from the institutions. With major players Apollo and Carlyle able to build funds around 10 billion in size, funds raised for private equity have reached $199 billion. This is $35 billion more than the same time last year.

Looks like a good time to be a business owner trying to sell to private equity. It also reminds me of the tech bubble where the greatest cash inflows came in the four months before the crash.

Homebuilders Index off 68%

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2007-09-14T16:02:05-04:00

While retail investors are selling out of their REIT's and watching the value of their homes decline, the smart money on Wall Street is gearing up to buy everything on sale. The S&P Homebuilders index (ETF: XHB) peaked in July of 2005 and has fallen 68% since then. The real estate bust has sent individual investors running for the hills, while veteran investors like Warren Buffet, Bill Miller and The Carlyle Group have rolled up their sleeves and started buying into the weakness.

They have proven to be a bit early, but listen to what Bill Miller had to say in his recent letter to investors: "The headlines today are all about this being the worst housing market since the early 1990’s. Had you bought housing stocks during that previous period of duress, you would have made many times your money and handily outperformed the market over the subsequent decade."

While Buffet and Miller have focused on the homebuilders, other institutions are not shying from buying hard assets. Carlyle just finished raising $3 billion for a private equity fund and it plans to put it to work in a relative value strategy. The leverage will be low, they will only borrow $4 billion, giving them a total of $7 billion to invest. One thing's for sure, a weak dollar is making U.S. assets like real estate look more attractive to foreign investors and over the next few years their appetite for these discounted assets may be the stabilizing factor for the sector.

In 2005 the homebuilders index signaled the eventual real estate slow down. It acted as a leading indicator falling before other housing related stocks and as a result it is likely to be the first real estate sector to turn around. While the average individual investor is thinking, "real estate is just getting worse!" and the average institutional investor is saying, "I can't buy them because I need to make next month's numbers," investors with a longer time horizon, like Warren Buffet and Bill Miller, are likely to be well rewarded. Most people are calling for the real estate slowdown to continue into 2009 and 2010. If that prediction is true, it's likely that housing related stocks, and XHB, will bottom well before that time.

May: Best and Worst Asset Classes of 2008

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-05-20T15:57:16-04:00

We follow about 25 asset classes. Of those, here is what we're seeing in 2008:

What asset classes are winning in 2008 as of Friday, May 16?

1) +28.86% - Commodities (GSG)
2) +14.58% - Natural Resources (IGE)
2) +10.85% - Domestic Real Estate Investment Trusts (VNQ)

What asset classes are losing in 2008 as of Friday, May 16?

1) -4.76% Domestic Listed Private Equity (PSP)
2) -4.12% Domestic Micro Cap Stocks (FDM)
3) -3.46% International Listed Private Equity (PFP)

What about the broad markets?

Domestic Stocks (SPY): -2.17%
Domestic Bonds (AGG): +2.05%

International Stocks (EFA): +1.08%
International Bonds (BWX): +6.39%

Emerging Market Stocks (EEM): +3.19%
Emerging Market Bonds (PCY): +0.94%

Our Comments: Predicting the short term movement of any asset class is similar to predicting the weather, but over the long run we can be quite certain of their return. Therefore, the historic performance of an asset class gives us the best guidance for long term future returns.

We know that the long term returns of commodities are about 10%. When they outperform this rate for a period of years we should remind ourselves that they will have to eventually go through a severe correction to revert to their mean returns.

While we often include an allocation to commodities in clients' portfolios, we are well aware that the odds of a severe downward correction are increasing. Earlier this year we were rebalancing into real estate and domestic stocks (at the time they were underperforming); now we are evaluating rebalancing into underperforming classes like private equity and micro cap. This helps us manage the risk of our portfolios and ensures that we are selling high and buying low.

Important Disclosure

June: Best and Worst Asset Classes of 2008

greg.skidmore@belrayam.com (Gregory H. Skidmore) — 2008-06-15T15:56:16-04:00

What asset classes are winning in 2008 as of Tuesday, June 10?

1) +33.24% - Commodities (GSG)
2) +11.89% - Natural Resources (IGE)
2) +3.10% - Domestic Real Estate Investment Trusts (RWR)

What asset classes are losing in 2008 as of Tuesday, June 10?

1) -10.97% International Real Estate (RWX)
2) -10.64% International Listed Private Equity (PFP)
3) -9.31% Domestic Listed Private Equity (PSP)

How are the broad markets as of Tuesday, June 10?

Domestic Stocks (SPY): -7.00%
Domestic Bonds (AGG): -1.22%

International Stocks (EFA): -7.01%
International Bonds (BWX): +0.82%

Emerging Market Stocks (EEM): -6.17%
Emerging Market Bonds (PCY): -0.32%

Our Comments: In the last 30 days we have seen the return of volatility to the markets. Oddly enough, there has been strength from micro cap (FDM). Since our last email it's only down -0.24% and considering the S&P 500 (SPY) has fallen -4.62% during this same period, that's quite remarkable. Historically micro cap and small cap has led us out of recessions, so if we are in a recession those are the asset classes that may signal a recovery.

If you go back 10 years (June 6th 1998) and take a look at the S&P 500 (SPY), the market appreciation is only 24%. That's an average annual return of 1.89% over that 10 year period. With S&P 500 having a long term annualized return of 10% to 12%, we've got a significant deviation from the mean return. So what does this mean? We feel that US stocks are due for a rally in the next few years.

Just as the emerging markets quietly started their charge towards the tail-end of the dot com boom, we feel that towards the tail-end of this commodity boom US stocks will start their next upward move. In the last week, almost every asset class has gotten killed. However, there has been surprising relative strength from the S&P 500, which is a rare occurrence. We'll be watching for a consistent trend change.

What do we do with this information? For one, we don't try to anticipate what's going to happen in the short run. Our firm studies very long-term trends and tries to build portfolios that do well through them all. Currently, our average University Endowment Styled Portfolio is up in 2008 (0.84% after fees). Our portfolios are generally globally diversified so we just need one of the markets to improve for performance to kick up. We are constantly researching how to make our portfolios more stable without sacrificing return. Our historical research is designed to help us understand how to make those improvements.

Important Disclosure