Transparent as a brick wall

Inveska's algorithms are based on SEC-required disclosures that mutual funds must make.  Easy, right?  The SEC has a website, the disclosures are on there, so just go grab them.  It's that easy, right?

Well, it should be.  And for many fund companies, it is.  For Vanguard, Fidelity, Dodge & Cox, and others, it is that easy.

For some, it isn't.  In particular, T. Rowe Price and Franklin put their disclosures in JPG images.  So you can't simply copy and paste the information and do something useful with it.  Take a look at this disclosure from T. Rowe Price Capital Opportunity.

Now, I suppose they would argue one of two things:

1. They are trying to prevent a competitor from analyzing their trades.  Okay, I suppose, except that these don't come out in real time.  They come out a month or so late, so it seems that the competition excuse is a weak one.
2. It's for formatting - it makes them look better.  Of course, Fidelity and Vanguard have no problem making theirs look good without putting all the real data in images.

I think the real reason is clear - they're trying to prevent the very transparency that the SEC is trying to promote with these rules.  And shame on them for that.

You might want to think about that one

I'm sure Christine Benz from Morningstar would like to have that one back.  As recounted in this Moneywatch blog post by Nathan Hale, Benz said:

"You want a strategy that makes sense to you, that intuitively appeals to you.  For example, one strategy I find personally compelling is the contrarian strategy, where a manager is looking for high-quality companies but wants to buy them cheaply.”

Hmmm... as opposed to most investors, who want low-quality stocks that are expensive?  I know what she meant - she is arguing for a value strategy.  Of course, you don't need active funds to get a value strategy -- there is the Vanguard Value Index Fund (VIVAX), for instance.

Although, it is hard to argue that low-cost index funds are not the best option for the majority of investors.  But there are some studies that indicate that among active funds, those that are most active do the best.  We are not as religious about active/passive as Hale, but we do fundamentally believe that if you're going to pay for an active fund, you should get an active fund.

You're on the hook for bad funds

A recent Stuart Robertson article in Forbes should scare some 401(k) plan fiduciaries.  The article's third warning talks about how providers do not share your fiduciary risk.

"And while your rep and provider may have given you a list of funds to select from – and even suggested a few – it’s your responsibility.   The very investment expertise the rep is supposed to be providing is really fully on the employer.  Bad funds?  Your problem.  Employee complaints?  Your problem."

We agree.  If you're a plan sponsor you shouldn't blindly trust your provider.  You should get your own information to be sure you're not being put into a fund solely because of the soft dollars they'll pay.  You need to know the funds you're in can be trusted.  You should share your data with the employees in your plan, too.

Inveska will help.

Don't be a fees patsy

There are good arguments on both sides of the active vs. passive management debate.  At Inveska we don't adhere to one side or the other, but we do want you to get the best value out of your investments.  Evaluate closely all the fees you pay to ensure you are not paying for something other people get for free.  Edward Siedle at Forbes framed it nicely when he wrote, "Remember that a Timex tells better time than a Rolex; a Toyota Corolla is more reliable that a Rolls Royce and a low cost index fund almost always performs better than more costly alternatives."

Don't panic on treasuries, but corporates need fixing

The recent Shifting Bond Maturities and My Latest Mistake post by Mike at Oblivious Investor got me thinking about bonds.  When you're holding bonds, you shouldn't really worry about rising interest rates that much.  Sure, their value would fall, but you would rebalance, buying more bonds, and you would end up holding your older bonds to maturity.  No big loss - the older bonds will approach par value as they near maturity.  The new bonds that you're buying will be yielding more, so you end up doing fine as explained by a Vanguard research paper.  So I agree with Mike - stick with your intermediate term bonds, and don't worry too much about it.

When we get out of treasuries and into corporates, we face a lot more issues.  Among them are that the indexes overweight high levels of debt as Matt Hougan points out on IndexUniverse.  It seems to me that there are some simple tweaks that could be used to improve the indexes.  If we assume that the market is somewhat intelligent and demands a higher yield for a good reason, why not just divide issue size by the current yield-to-maturity?

Credit ratings need to be market-based

It has been a tough few years for credit ratings agencies.  We had the financial crisis with toxic subprime bonds going down at absurdly high ratings.

Most recently S&P downgraded the US Government to AA+ from AAA, which fundamentally makes no sense.  Apparently Warren Buffet agrees.  Now, S&P may be right to be worried about the long-term sustainability of US debt levels.  What I don't understand is how Microsoft bonds can still be AAA.

Let's go through a little thought experiment.  Let's say the US Government starts to get into trouble and bond investors everywhere start demanding higher interest rates.  Most would consider an actual default incredibly unlikely.  It is much more likely that the Fed would ease to drive interest rates back down.  That's right, the government would print their way out of the problem.

But Microsoft issues their bonds in dollars, same as the US.  And oh by the way, they have 51,000,000,000 of those same US dollars on hand - probably sitting mostly in Treasuries.  So a devaluation of the dollar certainly would have a big impact on Microsoft.  So again, if the US government isn't AAA, it is hard to see how Microsoft should be AAA.

Over at IndexUniverse, Matt Hougan wisely points out in his bond indexes post, which I have referenced before, that we should prefer a market-based approach to the question of bond quality.  You can be assured of one thing - Inveska will never take credit ratings seriously.

Swensen explains how mutual fund ratings are no help

David Swensen, former head of Yale's endowment fund and author of one of the best books about investing for individuals, recently wrote a guest editorial for the NY Times. He calls out almost everyone - individual investors, mutual fund companies, regulators, and Morningstar.

About Morningstar's famous ratings, he says "But the rating system merely identifies funds that performed well in the past; it provides no help in finding future winners. Nevertheless, investors respond to industry come-ons and load up on the most 'stellar' offerings."

At Inveska, we agree. That's why we look beyond past performance.

A reasonable portfolio

A lot of effort in the investment space has gone into giving people advice about their proper asset allocation. There’s a good reason for that – academic studies have shown that over 90% of variation in returns is determined by asset allocation. As a result, there’s a lot of advice out there. Academics talk about efficient frontiers and Monte Carlo simulations. Companies such as Financial Engines and Betterment have come along to help people.

Me? I’m more in the William Bernstein camp. The problem is that the inputs to the models are unknown. Things like the risk premium accorded to equities and correlations between asset classes are not very stable over time. Plugging historical data seems unlikely to work – times change, there are different periods, and the future almost certainly won’t look like an average of the past. Having written a Monte Carlo simulator for these types of things, I can tell you that it’s mostly junk. The answers you get heavily depend on whether you think the risk premium for equities will be 4%, 4.5%, or 5%, or other such wonky inputs. I wouldn’t believe anyone who says they know which it will be.

So what do you do, then? I’d start with simply being diversified and rebalancing your portfolio yearly. Also, no matter what you decide, stick to it. You don’t want to introduce unnecessary churn, and you don’t want to chase performance.

Beyond that, here is a reasonable portfolio. It probably won’t be the optimal portfolio over any time horizon, but, hey – it’s worth what you paid for it, and it’s probably just as good as anything else you’ll see.

30% US Large Cap (iShares IWB)
15% US Small Cap (Vanguard’s VB)
20% International (Vanguard’s VXUS)
10% Emerging Markets (Vanguard’s VWO)
5% REITs (Vanguard’s VNQ)
10% Treasuries (iShares IEF)
10% TIPS (SPDR IPE)

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