Many Quite Different Markets are in “The Market” - Weekly Blog # 855

 

Mike Lipper’s Monday Morning Musings

 

Many Quite Different Markets are in “The Market”

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

Main Motivations

No one invests to lose money, even if there is a clear chance of loss due to a decline in prices, inflation, or currency values impacting spending. To reduce the odds of disappointment one can diversify, which in theory reduces the risk of a total wipe out. (Except from a large meteor or similar tragedy.)

 

As the potential number of investments is so large, most people choose to narrow the list down to a manageable number. Very few people make the choice of investing in their own work, which could produce the highest lifetime return on work.

 

For the most part, diverse investments are packaged by marketing agents to make choosing easier and generate a profit for the marketer and her/his organization. To make their job easier during their limited selling time, they wrap their sales pitches with labels. The three most popular labels in the fund world are Growth, Core, and Value. Investments are not labeled by the issuer or the marketplace where traded. Although the distribution and administration processes are significant, they are governed by economics. (If one can sell the same product many times, the marketing and administration cost per sale can be smaller than the distribution/administrative cost for selling only once.)

 

The main motivation for investors, after making money, can be summed up under two categories. Excitement & Entertainment and Generating Capital/Income for future spending. Many traders interested in the first category judge the market by following the Dow Jones Industrial Average (DJIA), along with the volatility of the Nasdaq Composite Index. Serious investors attempting to earn capital and income over extended periods focus more on the Standard & Poor’s 500 Index (S&P 500).

 

The biggest risk in owning any security is not the issuer or its traded market, but the risk created by one’s co-venturers. If a large enough number of investors panic, they can pierce a chart’s support levels and bring on more selling, which could bring on even more selling. If the stock is critical to the forward momentum of the market, the price action could end the current phase of the market.

 

Understanding Data

It is critical to understand how large-cap funds perform, because they not only have the largest earnings in the fund business, but in aggregate probably represent the largest allocation of investors’ money. (Large-Caps represent at least 80% of the general equity in stocks.) Excluding sector funds and global/international funds, large-cap funds represent 33% of assets invested in mutual funds, with growth funds accounting for $1.55 trillion, core funds $1.09 trillion and value funds $0.66 trillion. When I created fund measurement data, I found it useful to look at the totals three ways; weighted, average, and median. The resulting numbers are meaningfully different. Growth funds year-to-date to September 19th show a weighted average return of +17.79%, an average return of +14.61%, and a median return of +13.48%, for a spread of 4.31%. In the small-cap peer group the spread was only 0.54%, showing the impact of size on the results.

 

Impact of Universes

Through the end of the latest week the volume of shares traded for the year was up +12% for the NYSE and 31% for the NASDAQ. In terms of advances/declines, 69% of NYSE stocks rose while 59% rose on the NASDAQ.

 

Hunting Grounds

I was trained to look for badly performing stocks that might be big future winners. In looking at poorly performing fund sectors two sectors caught my attention, China Region and Dedicated Shorts. Both have produced five-years of loses.

 

It has also been useful to reduce commitments when a sector is changing its source of new capital. Private Equity funds are now growing in popularity with the retail crowd of advisors and their customers.

 

Conclusions:

Be careful, many investments are likely much closer to their next five-year’s highs than their five-year lows.

 

 

Did you miss my blog last week? Click here to read.

Mike Lipper's Blog: Implications from 2 different markets - Weekly Blog # 854

Mike Lipper's Blog: Investors Focus on the Wrong Elements - Weekly Blog # 853

Mike Lipper's Blog: Lessons From Warren Buffett - Weekly Blog # 852

 

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In the Hedge Fund Shadows

One of the ways that I try to give back to a society that has been very good to me and to my family is to volunteer at six non-profits. Often I sit on or chair investment and/or finance committees. In a few of these cases the committees have chosen to use hedge funds and separate accounts as well as mutual funds for their investing. During periods of volatility, often on the down side, there is considerable anxiety until the comprehensive monthly performance report is published.* There is fear that the results will be so poor that the committee will be criticized for not being on top of the portfolio deterioration that might have commanded some selling action. Most of the time one or more of the hedge funds is the last to disclose its performance, which holds up the report.

Back of the envelope

Trained as an analyst, I am often in the uncomfortable situation of not having complete and accurate inputs. What I attempt to do is to produce an educated guess as to the missing numbers. One approach, which goes back to being a scout or perhaps learned in physics or math class, was to measure shadows. In the classic experiment, if one could measure the size of a shadow and how far it was from the source of light, one could triangulate and determine the size of the object that was throwing the shadow. I use the same approach to guess the likely performance of a hedge fund.

This is not a commercial

My old firm, now known as Lipper, Inc, publishes daily, weekly and monthly performance records of almost all mutual funds in the world. While I have no financial relationship with the company, I am a user of its data for my commercial and volunteer investment advisory work. As a carry-over from when I was running the firm, it produces many investment objective indices of typically the 30 largest individual funds in each group. Since my sale of the operating assets of the firm to Reuters (now Thomson Reuters), there have been waves of “retail-ization” of hedge funds. To counteract some real and potentially large losses of mutual fund sales, various firms have produced funds that somewhat copy the techniques of hedge funds. At the moment, with new investment objectives tracking these funds, we must use their performance averages as substitutes for indices that do not exist. (For the purists in the community I would be happy to discuss the advantages of indices over averages).

What do the averages portray?

First there are four such new investment objectives that are titled: Absolute Return funds, Dedicated Short funds, Equity Leverage funds, and Equity Market Neutral funds. Second, in most cases, these are equity funds, and often their “shorting” is by selling short ETFs (Exchange Traded Funds). Third, their average expense ratios are between 1.52% and 1.73% before any performance fees, if earned. Fourth, they are somewhat constrained in their use of leverage by the Investment Company Act of 1940, as amended from time to time. This potential difference with the more unconstrained private hedge funds is one of the reasons that I use the mutual fund results only as an early indicator of what some hedge funds might produce. A tighter fit is possible by picking out specific mutual funds as a somewhat peer comparison with specific hedge funds.

The results

The average returns for the first 5 months of 2011 were:

• Absolute Return mutual funds: gained +1.20%
  
• Dedicated Short funds: lost -9.79%
  
• Equity Leveraged funds: gained +6.51%, (the best of the four new objectives)
  
• Equity Market Neutral funds: gained +1.02%
  

To put these results in perspective:

• S&P500 Index funds: gained +5.00%
  
• Multi-Cap Growth funds: gained +6.02%
  
• Multi-Cap Value funds: gained +5.78%
  
• Multi-Cap Core funds: gained +5.54%
  
• Large-Cap funds, on average, produced returns in the +4.6 to +4.75 range
  

Working conclusions

When the hedge fund numbers come out they are likely to be behind the publicly available mutual fund results. However, I expect there will be some spectacularly good results. The winners will possess great selectivity skills and may have used the greater flexibility that hedge funds have to their distinct advantage. I believe that performance numbers do not provide the answers to selecting investments for the future. Performance numbers should promote questions not answers. For example, if a portfolio has significant investments in financial services stocks, one should take into consideration that the average Financial Services (domestic) fund was down -2.74% year-to-date. Around the world banks and non-life insurance companies have been the worst investment group thus far in 2011. Part of the problem for these institutions is that for regulatory capital requirements they are being forced to own too much of their own government paper in addition to holding prior bad loans to other governments. At the moment the investing public, outside of speculating on a few IPOs, is not actively participating in the market place. [Disclosure item: I manage a private financial services fund that is only appropriate for long-term oriented accredited investors who believe in looking for depressed securities.]

*My good friend Larry Goldman, the CEO of the NJ Center for the Performing Arts (NJPAC), was kind enough compliment me and the members of the Investment Committee in pointing out that the Chronicle of Philanthropy ranked the estimated yearly return of 19.6% for the NJPAC’s endowment as #11 of the 72 endowments with similar fiscal year periods.

Correction to last week’s blog

One of the best members of this blog community quite correctly noted that I slipped the decimal to the right when I indicated that a doubling in 100 years was the equivalent of a 0.1% gain per year. Actually on a simple divisor basis it is 1% p.a., and a compound basis 0.70%. We have corrected the original blog on its website, www.MikeLipper.Blogspot.com .

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