Sunday, February 14, 2016

Four Investment Traps to be Avoided

1. Asset Allocation
2. GDP & Unemployment Statistics
3. Co-Investor Risks
4. Statistical Record vs. People


In an imperfect world I am always studying to see what I can learn that will help my clients to make smarter decisions. As an analyst I have never been satisfied with any given number as a complete summation of past or present events. In this search I often question the perceived accepted knowledge. Often I find the summary is either incomplete or wrong in the terms of usefulness for future decision making. This blog post deals with some of the generally accepted views.
Asset Allocation

As we all are very much aware, investment performance has left a lot to be desired recently. In preparation for an upcoming client discussion I was considering some managers of funds that put a great deal of faith in allocating portions of their portfolios to different asset classes- equity, fixed income and cash and whether their decisions led to better investment results. One of the fortunate elements of my investment practice is that I have easy access to my old firm’s data. Lipper, Inc., a ThomsonReuters company has produced a computer service known as Lipper for Investment Management. With some help, I asked to see the investment performance of Multi-asset mutual funds for the one year period ending January 31st, 2016. I compared the results with the proportion of each portfolio in the three main asset classes. The universe contained 433 funds. Some of these funds were the old Balanced fund type, some were Target Date Funds either with fixed or managed allocations; others were flexible funds that regularly used the three asset classes. Further I focused on the top quintile in each sort of performance and asset classes. Thus to be in the top quintile a fund had to be in a select group of 86 funds. Over this particular period the universe on average produced a small single digit loss. The single best fund was up + 3.14%.

One would have thought that the funds that had the highest portion of their portfolios in cash would have done the best in view of the general market decline. Only 21 out of 86 of these funds were in the top performance quintile. Only 32 funds with the largest commitment to fixed income also were in the top performance quintile and finally 55 of the equity funds were in the group that showed the best results.

My working conclusion, assuming that this specific one year time period is representative of some future periods, is that while asset allocation can help performance it is less important than selection of individual securities. In the case of Lipper Advisory, as a manager of portfolios invested in funds, the individual selection of funds can be more important than sole reliance on asset allocation. (As this is a somewhat contentious opinion, I look forward to hearing from our subscribers with their views.)

GDP & Unemployment Statistics

Market pundits as well as politicians spout GDP and unemployment numbers as if they are accurate and meaningful. To me they are not to be used for decisions but as indicators as to what other people think who don’t spend time with people in the marketplaces of commerce and finance. It is these people as decision makers of both small things as well as large that affect the real world. That is why markets often move differently than the perceived numbers. While not as bad as the Argentine inflation numbers, which the new government is addressing so all can understand what is really happening; the US statistical budget has been starved for more than twenty years on an inflation-adjusted basis. Part of the problem with most countries’ GDP data is the failure to recognize the unreported numbers. One clue in the US and the Eurozone is that the fastest growing portion of both currencies is in large denomination bills, 100s and 1000s. You can guess who needs these and what they do with them. Further in the US there are at least six different measures of unemployment. If one takes the most severe and subtracts that from those employed the proportion of the population is indeed still large. Some might even suggest that these two factors (the under-reporting of GDP and the most severe unemployment) could be connected.

From my standpoint I do not put much reliance on the government produced numbers. I find it interesting that when the Presidents of the local Federal Reserve Banks get together they are questioned as to what have they learned from their interfaces with their local communities. Investors and portfolio managers do the same thing. Thus, my suggestion is to follow the markets for the best near-term feel as to direction.

Co-Investor Risk

Too many investors, including professional investors, focus on the risks of the issuer of the securities they own or are considering. To me there is almost always a bigger set of risks. The risk of my co-venturers in the security is the bigger risk. If enough of them want out immediately before I want to exit the security, their selling can damage my terminal price.  The current prices of financial securities are a good example. The MSCI Europe Financials index through February 11th is down ‑32%, the KBW Bank Index is also down ‑19% (26% since July) with the S&P 500 only down ‑8.8%. While there are some more non-performing loans in Europe, particularly in Italy, most Bank analysts believe the majority of banks are in better shape than when the last crisis hit. I believe the reason for the materially larger decline in bank securities is the fact that 45.9% of the oil-related Sovereign Wealth Funds were invested in financials. By the way, perhaps I am the only one that got nervous when we were told that Jamie Dimon bought 500,000 shares of JP Morgan Chase* stock on Thursday. This action reminded me of the quote from Mr. JP Morgan in 1929 that he and his son were buying. In the earlier case it worked for awhile but had no lasting stock price benefit. We will see what is the impact of Jamie’s purchase.
*Held in a personal account.

Statistical Records vs. People

There were lots of lessons from last weekend’s Super Bowl. There was no doubt that on the surface the Carolina team not only had a better record as well as a younger more athletic star quarterback, but they lost in a not too close game to the Denver team driven by a few very aggressive defenders who forced the supposedly better team to make mistakes. This reminds me that at times and under appropriate circumstances we select to invest with managers who we think are good and determined over those that have better records. Sometimes statistics can lead to the wrong decisions. Currently in the stock tables General Motors’ price/earnings ratio is listed at 5.5 times. This is historically cheap and therefore to some, attractive. We don’t follow the stock, but I wonder whether looking forward, the market is saying that the stock is selling more like 15 times or similar to the overall market or perhaps higher because the long-term outlook is for materially lower than recently reported earnings.
I am writing this blog post on Sunday evening, watching Bloomberg Television over my shoulder and seeing the Chinese-related markets are opening down even though their currencies strengthened during the Lunar New Year holiday.
I will be in my office on Monday.    
Comment or email me a question at:

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of 

Copyright © 2008 - 2016
A. Michael Lipper, CFA,
All Rights Reserved.
Contact author for limited redistribution permission.

No comments: