Sunday, October 30, 2011

Neuroeconomics, Asia, Cash Balance and “Total Return”

This weekend, while the east coast of the US was preparing for the season’s first major snowfall, Ruth and I were at the annual meeting of the Trustees of the California Institute of Technology.

Professor Antonio Rangel

One of the benefits in attending meetings of the Caltech Board of Trustees is to listen to various presentations of very learned professors. Professor Antonio Rangel, whose work we support, discussed the research he is conducting at Caltech’s Rangel Neuroeconomics Laboratory. His work shows that the brain assigns mathematical-like values to various choices, which leads to decisions. The values assigned to gains and losses can be different. (This is the case in selecting appropriate funds for the cash balance pension fund discussed later in this blog post.) According to Professor Rangel, an increasingly rapid serious of decisions leads to mistakes. Patient personalities tend to make better long term decisions. (One would hope those investors who experienced a decade-long trading range will be rewarded by an eventual upside breakout.)

Why Asia?

In response to my comment in last week's blog, "buy Asia," I note the following reasons why Asia should be important to investors:

  • India needs 1000 new universities within ten years. India is likely to lead the world in mathematically based programming, and China may lead in Engineering and Physics; both will need to catch up with Korea, with the most PhDs per capita.

  • Asian assets are expected to reach $4 trillion by 2015, driven in part by local mutual funds and other institutional vehicles.

  • The Korean National Pension Service is growing at $2 billion a month.

  • Thailand and India have government matching, voluntary contributions for non-government workers.

  • Slightly more generous retirement plan contribution limits will be allowed in the US next year. Increasing the limits of 401k and IRA accounts may lead to more flows into the long term portfolios of investors (including the working wealthy), which will enlarge the amounts to be invested internationally.

  • More money is likely to flow into Asian funds and securities. Asian investments will be attractive to US and European investors on a comparative basis, and to Asians themselves with their growing cash piles.

  • Merrill Lynch expects the United States to suffer another credit rating downgrade, a recognition of the long term decline in the quality of our country’s credit.

  • Asian countries are carrying less debt than the US and Europe relative to the size of their economies, and lower levels than in their earlier crisis periods.

  • Chinese stocks have been in a decline at least for one year, while China's economy continues to grow, albeit slowing.

  • Despite the current image, the Japanese market is gently rising.

Cash balance pension fund / absolute return mismatch

I have been asked to create an investment strategy for a new cash balance pension account. This particular account will treat the loss of a dollar more painfully than it would welcome the gain of a dollar. In researching the proper approach, I have identified a conflict in the naming implications between the institutional and mutual fund worlds.

People in the institutional world are comfortable with the term "absolute return," meaning vehicles that are designed to produce a specific numerical return, e.g., 4 percent regardless of what the general market indices return. Some of the smarter institutional investors are dropping the term “absolute return” for various Long-short and derivative-laden investment vehicles. The term is not used by responsible people in the mutual fund business because some might imply a type of guaranty. Thus, I can not turn to an absolute return mutual fund category. As is often the case, I have to devise my own screens to produce a list of candidates. In terms of equity funds, my criteria are:

  • Twelve month fund dividend yields between 3 and 6 percent,

  • Assets above $100 million,

  • Expense ratios below 1.25 percent,

  • Turnover rates below 100 percent, and

  • Active portfolio manager tenure of ten or more years.

One could argue I am being too restrictive. Nevertheless, I am coming up with a list too long to conduct further, in depth research. Please note that for the moment I am not restricting my search to domestic funds, however considering the nature of the cash balance pension plan, we are initially restricting our search to SEC-registered vehicles.

Does anyone in our blog community have some additional or better screens to use? If so please contact me quickly at
Did you miss last week’s blog? Click here to read.

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