Sunday, June 19, 2011

Going Global is No Escape from Investment Problems

  • Too Much Correlation
  • Four Letter Word: Jobs
  • Fragmented Markets = Less Liquidity
  • SEC’s Other Unintended Consequences
  • A Father’s Day Focus For Wealthy Investors

Too Much Correlation

You would think after suffering through 2008, when almost all investments went down, we would pick equity investments that were not extremely correlated. Many US investors, particularly those who have had long term exposures to the economy and the stock markets, are unhappy with the current situation of a lackluster economy combined with an excessive US government intervention/manipulation into the financial structures of the economy. There are two fears at work; first there are growing signs of stagflation. (A flat economy with an increase in recognized inflation.) The second fear is the uncertainty of the structure and rates of various taxes. To escape these increasingly perceived problems, many investors are opting to go global.

The ever adaptive mutual fund business has generated a large number of Global funds to fill the needs of investors. These funds, unlike International funds, allow the portfolio managers to select the best available investments whether they are traded in the US or elsewhere. The problem is that this enlarged hunting ground has not produced materially better results. As a matter of fact, the list of fund indexes of various global fund categories has produced somewhat poorer results in the first five months of 2011 than the domestic funds. (Some domestic funds can invest up to 25% in international securities and there is no limit to their investment in multinational companies.)

Out of a larger list, I selected six pairs of fund indices to compare. The first index listed is the global group, comparing with the second group, a similarly focused domestic fund index:

  • Global Multi-Cap Growth = 6.30% vs. Multi-Cap Growth = 8.61%
  • Global Multi-Cap Value = 6.28% vs. Multi-Cap Value = 8.23%
  • Global Multi-Cap Core = 6.71% vs. Multi-Cap Core = 7.98%
  • Global Health/Biotech = 16.54% vs. Health/Biotech = 17.90%
  • Global Sci. & Tech = 7.93% vs. Sci. & Tech = 8.56%
  • Global Real Estate = 8.35% vs. Real Estate = 12.75%

Source: Lipper, Inc.

Four Letter Word: Jobs

One of the main reasons that “going global” is not working is that in most developed countries, and in a great many developing countries, there is widespread unemployment (as well as underemployment in the US). Globalization has worked too well. Capital has poured into companies and industries that could improve their productivity through the increased use of global technology. Thus we are producing more with fewer people. An important global issue is that we are not creating jobs. The way both China and Brazil are addressing these pressing problems is by raising wage levels, particularly at the entry levels. They are, in effect, inducing inflation that will create later problems for many and opportunities for some. Over-population is not a new problem. Historically, one answer was to wage wars on neighbors, particularly for their land, and in some cases their women. Also life expectancy was limited until the impact of modern medicine and modern agricultural processes became widespread. There is one crying need for vastly under-funded investment in almost every country: infrastructure. Once again China is in the clear lead here. Infrastructure funding historically comes with three problems. The first is the displacement of people from their homes and farms without adequate replacement. The second is that succeeding governments use cutting infrastructure spending as a way to avoid raising taxes. The third is that the very nature of infrastructure spending is that, at some level, it is a cash business which makes it more susceptible to corrupt practices (particularly with low level local politicians). Despite these real drawbacks, if various societies are going to prosper in the future, our global infrastructure needs must be met. At this point I would prefer not to invest in various infrastructure funds, but in more broadly based funds that can move into and out of infrastructure investments as price and circumstances dictate.

Fragmented Markets = Less Liquidity

One of the reasons that the global markets have become much more correlated is that with the exception of some Asian markets and to a lesser extent the UK market, the main driving forces in the marketplace are institutional investors. Many of these are managed by people who have been educated and/or had training in a limited number of universities or major firms. This somewhat limited exposure has produced generally accepted ways of thinking aided by instant global communications. In the search for meaningful competitive advantage, the players have to find more restrictive card games (markets) where only a few serious (big money) players are at the table. This has led to the creation of numerous places to trade. In effect, this move destroyed the knowledge capital of the formerly central marketplace. As no one knows for sure what transactions are currently occurring, there is a reluctance to provide liquidity to the marketplace. In turn, the lack of identifiable liquidity leads to increased volatility. Increased volatility scares many retail investors, so they retire from the marketplace. In the past, at the time of investment, individual investors were looking to the long term for their gains. The focus of too many institutional investors was defending against career risk, i.e., they needed superior performance in the present quarter. Markets work best when investors with different time horizons meet. Thus, one investor could be focused primarily on today’s price and another on some future price. That way both could be right. The absence of longer term-oriented investors in the marketplace hurts finding equilibrium prices, which promote future investment.

SEC’s Other Unintended Consequences

The fragmentation of the US market is a direct consequence of the SEC’s belief that “better” prices could be achieved through competing marketplaces which would aid the individual investor. As is often the case with government intervention, the unintended and unanticipated consequences have led to harming the very people who the changes were meant to help. I am not attempting to change these market structures through this blog community. I am just suggesting that the impact of what was designed to help investors, I believe hurt them. Another example tied to the fund index data shown above is the term global. The SEC cannot directly dictate a fund’s investment objective, but it can dictate as to its name under the concept of Truth in Advertising. At an earlier time, when US investors were pouring money into funds, the commission was concerned that investors could wind up in a non-diversified fund in terms of exposure to various foreign markets. That is why they insisted that for a fund to be called “global” it had to be invested in at least three different countries. In truth many of these funds invested in many countries and from my standpoint, too many countries. (When I used to counsel new funds, I suggested that they should not put a geographical or investment term in their name.) One of the reasons for the closeness of the performance data shown above is that too many of these funds are too broadly diversified, thus they will hug the middle of the market and not attempt to do extremely well. When examining a fund, investors should look at the fund’s portfolio to get their own view as to what the fund holds, and therefore how it should be measured to meet their own needs. If an investor cannot, or chooses not to perform this analysis, then the use of a competent investment adviser is warranted.

A Fathers’ Day Focus For Wealthy Investors

This blog was written on a day that is celebrated as Father’s Day in several countries of the world. For many, this was a day of family gatherings, exchanging cards/electronic messages, and gifts. When thinking about the upsurge in communicating with one’s family, there is a natural tendency to think about both the past as well as the future. Anyone who has children is wealthy beyond any commercial successes derived. Thinking back to one’s own father and grandfather, there has to be recognition that in many cases they are no longer with us. Turning to the future, we need to absorb the fact that at some point in the future our children will probably be looking back to a father or grandfather who is not with them on some future Father’s Day. All fathers (and mothers) try to pass on to their children their values and perhaps their talents. If you can do this, you are indeed wealthy.

For those who have financial assets, particularly sizeable assets, there is an added task, which is to pass on to children, grandchildren and great grandchildren not only financial assets, but the moral and investment values that have the best chances to make them happy and productive people. There are many models and devices to accomplish these goals, however there is no single plan for each and every beneficiary. When we lived in a much simpler world where our main asset was a farm or a local business, often the heirs had to share in the ownership and management of the family asset. There was very little one could do wisely for one heir compared to another except in terms of decision making. Today most wealth is, or can be, converted into liquid form. In many cases the assets of the heirs can and should be handled differently. One way to start the process, while you can change it, is to create separate portfolios with different rules for each of the heirs. Working with your accountant and trust/estates lawyer in the early stage of this process, I would use mutual funds because of their relative transparency and flexibility. Once policy portfolios feel right, then they can easily be memorialized in wills and trusts. To start the process, give some thought to the use of investing outside of your home country. In all likelihood one should start small, and as experience and confidence grow, take bigger steps. Don’t you wish your parents or grand-parents did this for you? This effort can be a gift to your children and grandchildren in addition to passing them your values and talents.

Perhaps we can help a limited number of fathers and mothers out there.


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