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Trovena Blog Moved!

Trovena, LLC — Tue, 28 Dec 2010 17:09:49 -0800

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From the NYT, a Wall Streeter Comes Clean

Trovena, LLC — Mon, 06 Dec 2010 13:57:52 -0800

Great piece about a former Goldman banker admitting it was all a lie...after he gets cancer.

- Christopher

A Dying Banker’s Last Instructions

New York Times

There are no one-handed push-ups or headstands on the yoga mat for Gordon Murray anymore.

No more playing bridge, either — he jokingly accuses his brain surgeon of robbing him of the gray matter that contained all the bidding strategy.

But when Mr. Murray, a former bond salesman for Goldman Sachs who rose to the managing director level at both Lehman Brothers and Credit Suisse First Boston, decided to cease all treatment five months ago for his glioblastoma, a type of brain cancer, his first impulse was not to mourn what he couldn’t do anymore or to buy an island or to move to Paris. Instead, he hunkered down in his tiny home office here and channeled whatever remaining energy he could muster into a slim paperback. It’s called “The Investment Answer,” and he wrote it with his friend and financial adviser Daniel Goldie to explain investing in a handful of simple steps.

More...

The Secret Is Out: The Best Predictor of Future Performance

Trovena, LLC — Mon, 22 Nov 2010 13:37:34 -0800

One day in India, I met a fortune teller on the street that was predicting the future by means of a parrot selecting tarot cards from her old wooden table. It did not cost that much so I gave it a go. As it turns out, the parrot's prediction was accurate. I'm glad I did not spend a lot of money gaining insight into my future as my instincts tell me that the quality of the parrots performance probably would not have improved had I spent more money.

As it turns out, it appears the same truth holds for predicting future performance of mutual funds. A study released by Morningstar no less, shows that using low fees as a guide would have given investors better results than even Morningstar's own star-rating system.

How Expense Ratios and Star Ratings Predict Success

This study may further validate our strategies for building investment portfolios which hold some of the lowest cost mutual funds available. For our client portfolios, the average mutual fund expense ratio is approximatley 0.40% with no 12b-1 fees and no loads (commissions).

The Wall Street Journal article citing this study reports: "Morningstar found that in aggregate, low-cost funds had better returns than high-cost funds across all asset classes, during various periods from 2005 through March 2010."

"Low Fees Outshine Fund Star System" WSJ 8/9/2010

The study's author, Russel Kinnel, states “If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds....Expense ratios are strong predictors of performance."

For those of you looking for that "Five Star Manager", look no further. If this study is any guide to your investment decisions, Trovena has already found the "Five Star Manager" investments, and they are in our client portfolios.

By the way, the parrot told me I would help people and live a happy life.

Roth IRAs - To Convert or Not

Trovena, LLC — Wed, 10 Nov 2010 07:16:07 -0800

All of a sudden, it seems like everybody in the wealth management world is talking about Roth IRAs and Roth conversions. In fact, an article in Financial Planning magazine--one of the trade magazines in our world--recently proclaimed 2010 "The Year of the Roth."

What's the big deal? Roth IRAs are interesting to professionals for several reasons. With traditional IRAs (and qualified plans like 401(k)s), the money goes in untaxed, and you pay ordinary income taxes whenever you take money out of the account--which might be years in the future. The Roth reverses this; your contribution is made with after-tax dollars, but then there's no tax whenever the money is distributed. If you believe (I personally make no assumption about future rates. History has shown this to be impossible to predict.) that tax rates are going to go up in the future, then paying taxes now and eliminating future taxes provides a net gain.

It could get better. Having money in a Roth account gives you a lot more control over your tax bracket in retirement. For instance, you might take out just enough from your IRA distributions to fill the 15% bracket, and then take the rest of your living expenses out of your taxable accounts and Roth. Another version of this kind of planning might help higher-income retirees avoid the brackets where Social Security income is taxed. This flexibility certainly argues for a partial conversion.

Another interesting thing about Roths is that, unlike traditional IRAs, they don't have any minimum distribution requirements once you turn age 70 1/2. So long as the money remains in the account, both Roths and traditional IRAs give you the benefits of tax deferral, which eliminates a significant drag on the growth of your money. If you can afford to keep your money in the Roth account, and take retirement income from other sources, then the deferral can go on longer.

Alas, the Roth account will still be subject to estate taxes, and your heirs (not your spouse) will have to take required distributions each year once they inherit your Roth account. But they won't have to pay taxes on the distributions they receive--a nice additional gift for your children or grandchildren. Furthermore, money used to pay the taxes caused by the conversion will not be subject to estate tax. Once you've sent the tax money off to Uncle Sam, it is no longer a part of your estate. This is, to me, the most compelling reason to convert your IRA to a Roth.

As things stand now, in January each person will be able to shelter just $1,000,000 from the estate tax. For those of you with large IRAs and an estate value greater than $2,000,000, you may want to consider a conversion.

In the past, the only people who could set up a Roth IRA were those with less than $100,000 in taxable income, which eliminated a lot of the taxpayers who would benefit the most from all these features. But now, as of January 1, anybody can open up a Roth IRA. Most of the conversation in professional circles is about Roth conversions; that is, converting the money in your IRA to a Roth or taking a rollover distribution from a company retirement plan directly into a new Roth that you set up.

Should you do this? Unfortunately, that's a complicated question, since any money moving from a traditional retirement account to a Roth requires you to pay taxes on the money in the traditional account. Some of that can be deferred; with any conversion that takes place in 2010, the tax obligation can be split between the 2011 and 2012 tax returns, which represents a (very) short-term loan from the IRS. So professional advisors are looking at individual situations, looking for portfolio losses that can be used to offset the tax burden, projecting tax brackets over the next three years and a host of other issues, including how long each person will have the money in the Roth account, and where the money to pay the taxes will come from. (If you have to pay the taxes out of the IRA, then you lose the value of future deferral--not good.)

Another issue is: Do we trust Congress to keep its promise not to tax Roth distributions in the future? Few of us ever expected to pay taxes on Social Security payments.

Fortunately, the law allows for partial Roth conversions--moving some of the money over, rather than all of it--and also lets you reverse the conversion (professionals call it a recharacterization) any time before October 15 of the year after the conversion. All of this means that the conversion decision, and the amount to convert, will probably be different for you than it is for the person next door, whose decision will be different from the family down the street.

Meanwhile, you have to wonder how alert are the people who write our tax laws. Under the current rules, single persons earning more than $105,000, and joint filers over $167,000, are sternly prohibited from making a full contribution to their Roth account. If you earn more than $120,000 (single) or $177,000 (joint), you're forbidden to make them at all.

But... People in these income brackets are perfectly free to make a traditional IRA contribution--and the law says they can immediately turn around and convert the money into a Roth account. Does that make sense to you?

*This article was adapted from one written by Bob Veres

The Morgan Report: 3rd Quarter 2010

Trovena, LLC — Wed, 20 Oct 2010 09:23:47 -0700

Good advice is not intended to make you feel good. Good advice is meant to help you avoid mistakes. A quote from a recent Wall Street Journal article that references new studies on investor behavior:

“...suggest that investors are doing what feels good, rather than what most experts believe is right. If you fall into that category, you may want to toughen up and learn from the mistakes of others.”

WSJ “To Be A Winning Investor, Know the Risks” Chuck Jaffe, October 11, 2010

Looking at client investment returns this quarter, it is evident investors are not making the mistake of others but reaping the benefits of our expertise. We respect the confidence you place in us and work hard to maintain your trust. Fortunately, you have access to superior institutional investments unavailable to the vast majority of financial advisers.

Most importantly, it’s good advice and superior portfolio construction that have helped my clients capture returns available in the market.

Look at quarterly returns (Q3 2010) for the selected index and index proxies:

Table 1

Sources below

The first observation for the third quarter is that investments were up across all asset classes. Investors on the sidelines, holding cash really missed out. When investors miss these periods of positive returns, over the long run, it can have a significant negative impact on wealth creation.

International Real Estate continues it’s robust growth from the second quarter and domestic real estate has performed quite well with a superior one-year increase of 30.57%. When it comes to lower risk investing, diversification, not just across asset classes but within funds as well, is critically important. For example, the Dimensional Fund Advisors (DFA) REIT fund holds approximately 106 companies focused on real estate domestically, while the DFA International REIT fund holds approximately 193 companies focused on real estate internationally. That is true global diversification with daily liquidity, at a low cost with fund expense ratios of 0.36% and 0.43% respectively.

Emerging markets (EM) is another success story with DFA Emerging Markets I returning 18.28% for the quarter. EM will continue to play an important role in client portfolios well into the future, along with DFA EM Small and Value funds, which returned 22.99% and 20.15% for the quarter respectively.

To learn more about DFA EM, follow my blog. This includes expanded information regarding DFA’s team of professionals, who were recently recognized for superior performance by industry experts.

Morgan Smith IMBA CFP® Blog

Investors holding EM investments have been smarter than most. A recent article in the Wall Street Journal notes that EM has been “grossly under represented in investor holdings”. Although EM will account for 47% of world GDP this year, Goldman Sachs estimates that EM account for only 6% of domestic institutional investor equity in their portfolios. This article also notes that the International Monetary Fund says that advanced economies will grow at 2.7% in 2010 but emerging economies will streak ahead at 7.1%.

Knowing that prognosticators get it wrong about half the time, the point here is that a well thought out plan will include investments like EM in a portfolio prior to a run up like we are seeing. This has been an effective way to build wealth, and is the reason why people getting good advice typically do better than those that do not. Currently, billions of dollars are flowing to EM from equity funds, and many individual investors will be chasing some newly minted star managers only to find they may have already missed the boat.

Sizzling Emerging Markets Risk Overheating”, WSJ Oct. 14 2010

As it turns out, we have survived a recession that was worse than originally thought. Revisions to data by The Commerce Department have painted a bleaker picture of what we actually experienced. Fortunately, having survived the storm handily, my clients are more concerned about the future.

To be sure, there are some important factors that will affect you. Taxes, pension obligations at the local, state, and national levels, estate tax law, bank health and lending guidelines, and government spending, to name a few. So, although we’ve had a good quarter, it will be even more important to make smart decisions for the long haul to both reduce risk and capture returns. The days of monkeys throwing darts at a stock board and getting rich are nowhere in sight.

Bill Gross of Pimco published an article in September of 2009 entitled “On the Course to a New Normal”, wherein he essentially states that the global economy is heading into a ‘new normal’ for the next ten to twenty years where economies grow more slowly with an expectation of lower investment returns. Time will tell whether or not he is correct. But, I very much like how he wrapped up his thesis:

“Like playing in an Open Championship, future golfers/investors need to play conservatively and avoid critical mistakes.”

This ties in neatly with my message at the beginning of this report, avoid making the mistakes that others are making, and if you do make mistakes, be sure you don’t make critical mistakes. This nuance could literally mean the difference between having enough or losing it all.

Excellent advice and superior investments from a fiduciary with no conflicts of interest will go a long way in getting you there.

Table 1 Sources: standardandpoors.com, wilshire.com, mscibarra.com, morningstar.com, russell.com, Dimensional Fund Advisors

Active Investment Management Fails Again

Trovena, LLC — Wed, 13 Oct 2010 12:57:47 -0700

Below is a story from the WSJ that perfectly illustrates one of the major problems with active investment management (trying to beat the market by foretelling the future). The story focuses on DE Shaw, a firm that, since its inception in 1988, focused on letting a computer decide when to buy and sell securities. I guess they had good (or lucky) results prior to 2006.

All of the sudden, in 2006, the managers decided to abandon the computer-as-crystal-ball concept and invest in raw land in New Mexico?????? What does a firm who purports to have a computer that knows the future about stocks and bonds know real estate development? Apparently nothing as they are soon going to lose all of their clients' $100 m investment on this boondoggle.

We call this "manager risk" or the risk that your active (the opposite of an active investment manager is a passive one who simply accepts the market rate of return rather than betting on certain outcomes) investment manager goes haywire and invests in something entirely different than you expected. The solution to this problem is to use a passive manager and to have a written investment policy statement (IPS) to guide your advisors. The IPS constrains investment managers to certain asset classes and performance standards. To me, the DE Shaw affair is another nail in the coffin of the scam that is active investment management.

- Christopher

D.E. Shaw Land Bet Proves a Quant's Quagmire

By LINGLING WEI

For more than 300 years, a huge swath of land in what is now New Mexico endured the rise and fall of empires, the arrival of settlers and development of the surrounding area into the city of Albuquerque.

But the Atrisco Land Grant, handed down by Spain's king and queen in 1703, has never seen anything like the real-estate disaster now gripping hedge-fund firm D.E. Shaw & Co.

Known for its obsession with computer-driven investing, the New York company surprised many real-estate deal makers in late 2006 by teaming up with developer SunCal Cos. to buy the 55,000-acre property—twice the size of Boston—for $250 million.

The two companies planned to create a new town with residential, commercial and industrial areas. But the nationwide real-estate slump left the project stuck on the drawing board. Last month, lenders led by U.K. bank Barclays PLC foreclosed on the property. D.E. Shaw and SunCal have only a few weeks to come up with the money needed to pay off the lenders, or else the hedge-fund firm could see its roughly $100 million investment wiped out.

Read the full article...

Emerging Markets - Emerging Ideas - Emerging Solutions

Trovena, LLC — Tue, 05 Oct 2010 07:50:14 -0700

Emerging markets play an important role in a well diversified portfolio. Risks exist when investing anywhere and especially in emerging markets where higher perceived political risk is an important factor. Volatility can be high, but the potential for return relative to risks and the possibility of reducing correlation (and thus risk) of an overall portfolio, can be an added benefit.

What is an emerging market? The term was coined by Antoine W. Van Agtmael of the International Finance Corporation of the World Bank in 1981. It is generally defined as an economy with low to middle per capita income. These countries happen to constitute about 80% of the global population that represent about 20% of the global economy. It sounds pretty straight forward but believe it or not, China and Peru can both be classified as emerging market economies! So, it’s obvious that how you implement your emerging market strategy is critical due to risks and widely varying characteristics of countries that can be included in this category. How then, is the best way to invest in this asset class?

On September 29th 2010, I searched for ‘emerging markets’ in Morningstar and the first mutual fund that came up is called Aberdeen Emerging Markets (GEGAX). This is a ‘3 Star’ mutual fund with 13.64% ten year annualized return (see morningstar.com for return assumptions), a 1.77% net annual expense ratio, and a 5.75% up front purchase commission (paid by the investor). Great return but those expenses add up. Compare that to Dimensional Fund Advisors (DFA) Emerging Market I (DFEMX) which we utilize for our client portfolios. According to Morningstar, this fund has a ten year annualized return of 13.61%, and an expense ratio of only 0.62%, with no purchase commission. First lesson, investing in emerging markets can be very expensive, or very cost efficient, with similar performance; your choice. As a fiduciary, it’s easy for us to make that choice for our clients.

It doesn’t stop there. Unless you are trying to find opportunities to pay more taxes, you will want to take a look at fund tax efficiency as measured by turnover. For example a 100% turnover for a mutual fund means that 100% of the funds investments were sold for a previous year, this would be very tax inefficient due to pass through gains for fund investors. The lower the turnover, the more tax efficient the fund is. Aberdeen Emerging Markets fund has a turnover of 93%. compared to a much more tax efficient DFA Emerging Markets fund with a turnover of 14%. Higher turnover means less after-tax money in your pocket, and can lead to some surprises. For example, Morningstar lists Aberdeen’s one month before-tax return as -1.83% and it’s tax-adjusted return as -9.33%. This is indicative of some of the strange surprises you can sometimes encounter when you have high turnover.

So, now that we know we would like emerging markets exposure, with low expenses, and low turnover we can just find that one fund with “emerging markets” in its title; correct? Not so fast. Many emerging market funds are large and growth oriented. Picking just one may not give you proper diversification and exposure to companies that my provide superior returns. Just as in domestic equity exposure, you’ll want to ensure you have the proper exposure to both small and value companies as well in order to capture the small and value return premiums that have historically been shown to give higher returns than large growth companies over time. For our clients, we typically do this via three funds diversified in large, growth, small, and value companies utilizing the following three funds. DFA Emerging Markets I(DFEMX), DFA Emerging Markets Value(DFEVX), DFA Emerging Small Cap (DEMSX).

DFA arguably implements the most successful and research oriented investment process for investments. A recent article in Barron’s by Craig Mellow highlights how effective the DFA team led by Karen Umland has been:

“Yet Umland and her six-member portfolio management team have proved to be just about the best in their business over time. Emerging Markets Value I (ticker: DFEVX) ranks third among 204 emerging-markets funds tracked by Morningstar in five-year returns, with an annualized rise of 16.42%. Nicking it for second, at 16.71% is its smaller sister fund, the $1.4 billion DFA Emerging Markets Small Cap I (DEMSX), which Umland also manages. That torrid performance compares to a 10.2% annualized return on the benchmark MSCI emerging-markets index over the past five years, and a depressing annual loss of 2.2% from the Standard & Poor's 500.”

"Strictly By The Book", Barron's August 2010

Emerging markets are dynamic and require continued oversight and updates via a disciplined investment process. Recently, the DFA investment committee added Columbia, Egypt, and Peru for eligibility in their emerging market strategies after evaluating appropriate factors. Opportunities can come from the most unlikely places and we want to ensure our clients capture them when they do occur. To be sure, others may not.

Lastly, DFA manages approximately $161 billion in investments. Your broker will not have access to these investments as they are reserved for clients of vetted fiduciary investment advisers like us.

If you would like to learn more about the advantages of emerging markets in a well diversified portfolio, please feel free to contact me at any time.

401(k) Fee Lawsuits Are Up: Is Your Plan Vulnerable?

Trovena, LLC — Thu, 09 Sep 2010 12:12:21 -0700

If you run a business and have a retirement plan, you are most likely a fiduciary with responsibilities that include:

Acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them;
Carrying out their duties prudently;
Following the plan documents (unless inconsistent with ERISA);
Diversifying plan investments; and
Paying only reasonable plan expenses.

As a fiduciary there is also potential liability. "Fiduciaries who do not follow the basic standards of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of the plan’s assets resulting from their actions." - United States Dept. of Labor, "Meeting Your Fiduciary Responsibilities"

A recent article in CFO Daily News explains how there has been a recent spike in employee lawsuits due to excessive 401(k) fees. 401(k) Fee Lawsuits Are Up

At Trovena, we have helped hundreds of clients develop, implement, and administer retirement plans as a fiduciary partner. Our superior investment strategies and focus on lower expenses and fees go a long way in helping business owners uphold and defend the responsibilities of a plan fiduciary.

Please contact us for a second opinion on your existing plan or ask us how to properly structure a new plan. A much better plan than hoping you will not be held personally liable due to issues you are not aware of.

Some Good News for Investors

Trovena, LLC — Fri, 03 Sep 2010 10:30:54 -0700

I edited Larry Kudlow's blog a bit to de-politicize it for my purposes. I thought what Mr. Kudlow had to say about the economy was spot on so I'd like to share it with you.

- Christopher

The Business of America Is Business- Larry Kudlow

Corporate profits are at all-time highs and bond rates in the Treasury market are virtually at record lows. That’s a good combination for stocks, and it helped trigger a 255 point rally in Wednesday’s trading. What’s more, a surprisingly positive read on the ISM August manufacturing report delivered a strong blow to the double-dip recession pessimism that has plagued investors for many months.

Without question, the jobs picture is going to remain cloudy. There’s just too much uncertainty over the economy and the tax-and-regulatory threats coming out of Washington. Businesses can’t be sure about the costs of hiring. Meanwhile, over in housing — our other weakest sector — an inventory glut threatens further price declines.

But make no mistake about this: Businesses, at least the publicly owned ones, are in very good shape. U.S. firms scored a record $1.2 trillion in profits during the second quarter and are sitting on roughly $2 trillion in cash. Our private-sector companies are resilient, and they have recovered significantly from the economic plunge.

And while their hiring is still behind schedule, they have begun the process of investing in equipment, software, and other capital goods. Business investment in the June quarter rose 16 percent above year-ago levels. This is all to the good. Healthy businesses are crucial to the stock market as well as the overall economic outlook.

In fact, since 2001, business profits have doubled, even while the stock market dial has hardly moved. If Washington can just keep its paws off of business and let market processes work, firms will continue to prosper domestically and internationally and will eventually pick up their hiring.

I hate to sound too much like Calvin Coolidge, who after Reagan is my favorite 20th century president, but the business of America is business.

Yes, when second-quarter GDP came out last week, the revised 1.6 percent growth number was universally derided as a step on the road to a new recession. But not so fast.

In a blog titled “What Everyone Missed in the Revised GDP Data,” brilliant Washington economist Alan Reynolds noted that real gross domestic purchases, which are purchases by U.S. residents of goods and services wherever produced, actually increased 4.9 percent annually — a full percentage-point stronger than the first-quarter results. Reynolds blamed a government accounting miscue over falling import prices for a misread on the trade deficit that subtracted about 4 percentage points from GDP.

So import prices actually increased in the second quarter, which lends credence to the idea that the economy is doing better than folks think. And by the way, the bulk of those imports are being used for capital-goods investment, which is a good thing, not a bad one.

Smoothing out the quarterly ups and downs, the real economy is growing about 3 percent year-on-year, with the domestic economy rising by 3.7 percent. This is a tribute to the resilient and durable free-market system in America.

All this is good for stocks. Using conservative earnings estimates, the S&P 500 looks to be valued at a historically low 11.5 times earnings. That comes to an 8.7 percent yield on shares, compared with only a 2.5 percent rate on 10-year Treasuries.

In other words, profits up, rates down, tax cuts may be coming. In the new political environment, year-end tax-selling by investors may no longer be necessary in 2010 to beat the Obama IRS in 2011.

Let’s have a little optimism for change.