What Is A ‘Sophisticated’ Investor?

Everywhere I look in the investment media someone is talking about alternative investments. This is what the sophisticated investor is looking for. Many are still smarting from the tech crash of the early 2000’s and more recently the 2008 housing crash. They feel there must be a better way, at least for sophisticated investors like them.

English: Bernard Madoff's mugshot
English: Bernard Madoff’s mugshot (Photo credit: Wikipedia)

Your wish is my command. The Wall Street bullies have a ‘product’ for every season. You want alternative investments you got them. These alternative investments can include:

  • Managed futures
  • Private equity
  • Long/short ETFs
  • Leveraged products
  • Commodities (including gold)
  • Hedge funds
  • Real estate

Of course, this list is not all inclusive. But the message is clear these ‘products’ are for ‘sophisticated’ investors looking to juice up their returns. The pain of the recent crashes is fresh on their minds and they want to avoid the pain. This is a prime example of gambling and speculating with their investment dollars. This is not prudent investing.

The equity markets include all of the above. The Wall Street bullies are just telling you to overload in a specific market sector. Many of the above are described as inflation hedges. Except when you look closely. The inflation is not nearly as volatile as the alternative asset classes used to hedge it. WHAT???

Predictions and forecasts can all be rationalized after they are wrong. ‘It didn’t happen like I said it would because…column A, column B or whatever’.

Whether you are a ‘sophisticated investor or not working with an investor coach/fiduciary adviser will lead to successful results, long term. Each investors needs to develop their own portfolio and understand the level of risk they are assuming.

Remember Bernie Madoff had hundreds of ‘sophisticated’ investors looking to avoid losses and earn superior returns.

Stop empowering the Wall Street bullies and follow three simple rules of prudent investing:

  • Own equities and high quality short term fixed income.
  • Globally diversify.
  • Rebalance.

Although these are simple rules they have proven very difficult for individual investors to follow, consistently. In most if not all cases it will require the assistance of an investor coach/fiduciary adviser.

2012: Another Dismal Year for Active Managers and Market Predictors

The marketing machine of the Wall Street bullies relies on the short memories of the investing public. Each year the bullies make new predictions and each year the public follow these predictions to make investment decisions. Each year they fail in achieving market returns. If investors would develop a prudent portfolio and remain disciplined they would succeed long term. Stop listening to bullies with short term success. Fire your broker and hire an investor coach.

Hedge Fund Managers - Lynching Party Needed
Hedge Fund Managers – Lynching Party Needed (Photo credit: smallislander)

Regarding the performance of active managers in 2012, the data is starting to come in, and the picture is not a pretty one. The Bloomberg Global Aggregate Hedge Fund Index showed a paltry 1.6% gain through November 30th. However, this dismal performance does not seem to have deterred the trustees of the Nobel Prize Endowment who now plan to incorporate hedge funds because, according to Director Lars Heikenstein, “We see that we can get more return with less risk by doing that.”  While we wish him the best in this ill-fated attempt to defy one of the most basic tenets of finance, we suggest that perhaps he should try dropping his mother’s favorite vase off a high building to see if Newton’s law of gravity could be suspended for him as well. Among the better known hedge fund managers is John Paulson who killed it during the 2008 financial crisis, as documented in The Greatest Trade Ever.  He made the unfortunate prediction that European Sovereign bonds would tank in a similar fashion to mortgage-backed collateralized debt obligations. As in 2011 when his fund loss half of its value, his bets on European credit default swaps got his shareholders clobbered to the tune of 17%, as reported on December 5th in Business Insider.  Some of them are probably feeling like the greatest mopes ever. Like so many other fallen angels before him, perhaps he should have quit while he was ahead. Returning to the more mundane world of mutual funds, Bloomberg found that more than 65% of mutual funds benchmarked to the S&P 500 fell short of it, which is par for the course, according to the Standard and Poors Index Versus Active Scorecard. We look forward to seeing this report fully updated for 2012.William Buiter of Citigroup was among the many pundits who predicted the beginning of the dissolution of the European Union, starting with the exit of Greece. As we now know, these dire events did not unfold, and the MSCI European Index rallied with a healthy gain of 19.1%. While we could easily continue with many other predictions that did not pan out, we think you get the point, and perhaps it’s a little unfair of us to cherry-pick the ill-fated predictions while ignoring the accurate ones. The problem is that there are so many of the former and so few of the latter. If you were suffering from a prediction addiction, we hope you are now cured.

The Wall Street bullies have to find the next guru because they know past gurus do not repeat their performance for long. Predictions have value only for the predictor as a marketing tool. These predictions will only hurt your investment results.

Please comment or call to discuss how this affects you and your investment portfolio.

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Hedge funds: Going nowhere fast

If investors are seeking higher returns with lower volatility they are wasting their time. The Wall Street bullies understand that investors are driven by fear and greed. They use this to convince investors to move their money. Your best strategy is to own equities, globally diversify and rebalance. This along with discipline will reduce your anxiety and improve results.

Hedge Fund Managers - Lynching Party Needed
Hedge Fund Managers – Lynching Party Needed (Photo credit: smallislander)

The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply. A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds (see chart). As a group, the supposed sorcerers of the financial world have returned less than inflation. Gallingly, the profits passed on to their investors are almost certainly lower than the fees creamed off by the managers themselves.There are, of course, market-beating superstars, as you would expect in an industry with nearly 8,000 participants (and rising). The top decile of managers has served up returns of over 30% in the past year, according to Hedge Fund Research, a data provider. But a third have lost money, including some of the stars of yesteryear: John Paulson, celebrated as an investment wizard in 2007 for having foreseen America’s housing bubble, reportedly saw his flagship fund lose 17% in the first ten months of 2012, after a 51% fall in 2011.

The Wall Street bullies are continually looking for ways to attract new money. The record of hedge fund managers is similar to that of actively managed mutual funds. There are some lucky managers who outperform, Unfortunately past performance does not correlate with future results.

Please comment or call to discuss how this affects you and your financial future.

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Good and Bad News for Jim Cramer

When you are investing for a long term goal these specualting and gambling tactics are your number one enemy. When you develop a prudent strategy and remain disciplined you will succeed long term. Remember the Wall Street bullies want you to continue trading this is how they make money. It does not matter to the bullies whether you make money or not.

There is no indication that hedge fund managers have any special

Mad Money
Mad Money (Photo credit: Tulane Public Relations)

expertise in stock picking. According to an article in The Economist, the HFRX, which is a measure of hedge fund returns, is up only 3 percent as of Dec. 22, 2012. The S&P 500 returned 18 percent for the same period. The S&P 500 index has outperformed the hedge fund benchmark index for 10 straight years, with the exception of 2008, when both indexes sharply declined.

The evidence is overwhelming that no one has the ability to peer into a crystal ball and select outperforming stocks with any greater certainty than you would expect from luck alone. The forum CNBC gives Cramer serves to perpetuate a myth to the contrary, but it’s really more insidious. The daily grist of CNBC is a parade of self-styled market pundits regaling viewers with predictions about the direction of the markets, hot mutual funds, and undervalued stocks. Cramer’s show provides the underpinnings for their musings. The unstated premise is that, since Cramer has special insight, these people do as well.

CNBC lacks the courage to run a financial show that would counterbalance the errant nonsense of Cramer’s rantings. Consider how valuable it would be to investors if someone stood up to Cramer and discussed all the reasons why his recommendations made no sense. While CNBC’s fear of engaging in balanced financial reporting is understandable, because of its reliance on the securities industry for advertising revenues, its lack of ethics is indefensible.

Stock pickers need entertainer like Cramer to get investors excited about ‘beating’ the market. NO ONE can consistently predict the future, when these fund managers succeed it it a matter of luck and NOT skill.

Please comment or call to discuss how this affects you and your financial future.

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What has gone wrong with hedge funds?

When investors understand what their investments are doing anxiety is reduced and results improve. Hedge funds are too confusing for any investor to understand. The Hedge fund managers make a bulk of the money while the investor assumes all the risk. Always remember there is no free lunch. Past performance is no indication of future results.

Hedge Fund Managers - Lynching Party Needed
Hedge Fund Managers – Lynching Party Needed (Photo credit: smallislander)

Why the party endedContinuing with my example, another student sees the buck I pocketed and decides to enter my space. I find out that I can no longer buy that book for $20, as I have a competitor who bought the book for $20.25 and sold it for $20.75 to the student wanting the book. The arbitrage opportunity declined by 50 cents. Since it’s still an  attractive investment  opportunity, eight other students also compete, and soon the arbitrage opportunity is pretty much gone.

This 10-fold increase in competition is exactly what has happened, with hedge funds growing from $200 billion in 1997 to $2 trillion today.

This presented a dilemma for hedge fund managers, who wanted to make serious money and weren’t satisfied with the paltry 2 percent annual fee. The solution? Take as much risk as possible with their clients’ money. That extra risk entailed investing more in options and futures, which are all zero-sum games and where not a penny in the aggregate had ever been made. These alternative assets had far less to do with investing and were much more similar to betting on a football game.

Why the hangover continues

With most investments, you can take you licks and move on. Not so with hedge funds. I’ve had many clients who thought they could get their money back at any time, until I pointed to page 173 of the prospectus and the section where the fund manager has the right to limit or deny the withdrawal request. In some cases, years later I’m still trying to help clients get their money back from hedge funds. Being ahead of the curve helps, as I was successful in getting clients out of The Endowment Fund sold by brokerage houses before they “gated” withdrawals.

So while hedge funds have been a disaster for most investors, managers are still raking in the fees by limiting withdrawals. In short, these funds are an outstanding gig for the manager but not so good for the investor.

As author and money manager William Bernstein says, “there is no portfolio fairy” willing to magically reward upside and protect downside. Further, he says, “if you are at the poker table wondering who the patsy is, it’s probably you.”

NO ONE can predict the future. There is also no one who can earn equity returns with treasury bill risk. Investors continue to seek out the ‘holy’ grail of investing without success.

Please comment or call to discuss how this affects you and your financial future.

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Death of Zombie Pensions Will Be Worse Than 2008 Meltdown

The Wall Street bullies have taken their bad public relations problem and moved on. Their next target pension plans, endowments, etc. This is another example of why individuals must not fall for the next great product from Wall Street. It is a new bubble in the making.

English: Wall Street sign on Wall Street
English: Wall Street sign on Wall Street (Photo credit: Wikipedia)

Today, 4 years after the 2008 market meltdown, the nation’s pensions are gorging on toxins, which have already weakened them and which will, in the near future, outright kill them. Let’s call them Zombie pensions.It may surprise you to learn that Wall Street has wasted precious little time publicly defending itself after the 2008 market meltdown and taxpayer bailout. Everyone knows the nauseating truth that Wall Street pulled a fast one on the American public and there is no point, i.e., no money to be made by Wall Street, trying to soothe critics, such as the Occupy Wall Street crowd. Instead, Wall Street is busier than ever making even bigger grabs at the few pockets of American wealth still left – pensions, endowments, foundations and high net worth individuals.

Wall Street no longer has any interest in Main Street—the vampires have drained the blood from America’s middle class and are moving on.

The “garbage du jour” is high-cost, high-risk, illiquid and opaque alternative investments, such as structured notes, hedge funds, hedge fund of funds, and private equity funds.

These investments are designed to lock-in investor monies for, say, a decade, charge exponentially greater fees than traditional investments, provide substantial wiggle-room regarding interim investment performance/portfolio valuation, and delay accountability for years—until it’s too late.

When these time-bombs explode, the decision-makers responsible for selecting them will be long gone and the stakeholders will be hard-pressed to piece together what went wrong.

If you do not understand what your invested in then walk away. Alternative investments are another bubble in the making. The Wall Street bullies will destroy what’s left of the American pension system all to benefit their own greed.

Please comment or call to discuss.

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Pension Funds Making Alternative Bets Struggle to Keep Up

Pension plans are much like individuals when dealing with funding their retirement. Both try to reduce funding or lack of savings by taking more and more risks. This can be successful, however it is a matter of luck and not skill. The results many times end up being disasterous. Saving for retirment should include a prudent portfolio which is globally diversfied.

NEW YORK, NY - APRIL 12:  Billionaire Galleon ...
NEW YORK, NY - APRIL 12: Billionaire Galleon Group hedge fund cofounder Raj Rajaratnam (right) enters a Manhattan Federal Court with one of his lawyers on the second day of the defense phase of his trial for insider trading on April 12, 2011 in New York City. Prosecutors allege that Rajaratnam pocketed $45 million by illegally trading on insider stock tips. While Rajaratnam's lawyers contend that he made legal trades using public information, prosecutors have called it the largest-ever hedge fund insider trading case. (Image credit: Getty Images via @daylife)

An analysis of the sampling presents an unflattering portrait of the riskier bets: the funds with a third to more than half of their money in private equity, hedge funds and real estate had returns that were more than a percentage point lower than returns of the funds that largely avoided those assets. They also paid nearly four times as much in fees.

It is important to remember that pension funds are managed daily by ‘experts’ in the field. These ‘experts’ cannot find the right risky alternative investments. This debate will continue, however investors would be best served, long term, with prudently managed portfolios.

Please comment or call to discuss how this affects you and your company retiremnet plan.

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Surprising Investing Myths

These myths are communicated by the media and the financial institutions to keep money moving. After all the financial institutions cannot make money unless it is moving. These myths will keep you from reaching the true potential for your investment goals. There are three simple rules when investing for your long term goals…own equities….globally diversify…rebalance. These three rules will guide you and you must remain disciplined.

Investment Frontiers Symposia
Investment Frontiers Symposia (Photo credit: apec2011ceosummit)

Stellar Past Performance Is a Good Measure of Investment SkillEvery year, another fund manager is anointed as the “next investment guru” based on his recent past performance. It’s more likely he was just lucky rather than skillful. It can take a very long period of time (often 20 years or more) to determine whether the performance of a fund manager was luck instead of skill. Relatively few fund managers stick around that long.

If Only I Qualified for a Hedge Fund Investment

Be thankful you don’t. If you do, avoid the temptation. In his new book, The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True, Simon Lack concludes that hedge fund investors as a group would have been better off if they had simply invested in Treasury Bills. Lack bases his conclusion on publicly available data from Hedge Fund Research, Inc. Hedge funds are great investments for those who run successful ones, because of the excessive fees they charge: commonly 2 percent of assets and 20 percent of profits. This fee structure motivates them to take very high risks… with your money!

Investors are continually looking for the right answer to one question. Where is the best place to invest my money? There is no answer with regard to which asset class or fund manager. The real question should be what strategy will help me reach my goal.

Please comment or call to discuss how this affects you and your employees.

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What MF Global Can Teach You About Investing

In some recent papers, researchers argue that ...
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To invest for a long term goal you should know two number expected return and expected volatility. If you are trying to increase your return because of a lack of disciplined savings you will invariably fail. Unless you are extremely lucky or break the law.

You can learn some valuable lessons from this debacle. Here are some of them:High Returns Mean High Risk

The appeal of investments in hedge funds and commodities is the high return these funds can generate. The enticement of high returns blinds investors to commensurate risk inherent in these investments. The high fees and commission structure of these investments encourages fund managers to take big risks with your money.

There’s no free lunch in investing. Investments in hedge funds and commodities is speculation, not investing. The expected return of speculation is zero, or less when you consider high transaction costs.

Transparency Has Its Benefits

Publicly traded mutual funds are regulated by the SEC under the Investment Company Act of 1940. The Act requires extensive disclosure and independently audited financial statements. Mutual funds are required to have a Board of Directors, the majority of whom must be independent from the mutual fund company. Mutual funds use fund custodians, many of which are qualified banks. The banks segregate mutual funds securities from their other assets. If the mutual fund goes belly-up, customer accounts are safely in the possession of the custodian.

These protections are not foolproof, but they provide the minimal security you should insist on before you entrust your hard-earned money to any broker or advisor.

Investment Guru” is an Oxymoron

The media is understandably focused on the missing client funds from the accounts of MF Global’s clients. Relatively little attention has been paid for the reason for its demise. MF Global owned $6.3 billion in European debt. This large commitment led to demands for regulators to boost capital based on concern over Europe‘s debt crisis.

When you investing for a long term goal such as retirement, prudence must be the main objective. Beating the market is accomplished by very few and those that do are nothing more than lucky. Skill has very little to do with it.

Please comment or call to discuss how this affects you and your portfolio.

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Simple Investing for Troubled Times

In some recent papers, researchers argue that ...
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Actively managed funds are promoted because of the trading revenue they generate for the financial institutions. It does not matter whether the market is up or down the institutions make money on every trade. This strategy is not in your best interest.

Dump your actively managed fundsSeeking “alpha” is exciting. “Alpha” is the value a portfolio manager is supposed to add over its benchmark return. Since you can capture the return of a designated benchmark (net of transaction costs) by buying an index fund that tracks the index, purchasing actively managed funds makes no sense unless the portfolio manager is likely to deliver alpha. Here’s the rub, according to an exhaustive study, only 0.6 percent of managers produce alpha as a consequence of skill.

Don’t be fooled by pre-tax return data

Mutual funds report returns pre-tax. Most investors don’t understand the impact of taxes on their returns. The tax burden of individual investors varies depending on whether their accounts are tax deferred or after-tax accounts and the tax rate of their state of residence. Kritzman uses an example of a Massachusetts resident (admittedly a high tax state) who has a marginal tax rate of 35 percent. If this resident had a choice between an index fund with an expected return of 10 percent, a mutual fund with an expected return of 13.5 percent, and a hedge fund with an expected return of 19 percent, you would think selection of the hedge fund would be a no-brainer. You would be incorrect. At the end of a ten year period, after accounting for transaction costs, taxes, management and performance fees, the simulated return of the index fund was 8.27 percent, which beat the return of the mutual fund (7.82 percent) and the much hyped hedge fund (7.61 percent).

Here’s Kritzman’s conclusion: “It is very hard, if not impossible, to justify active management if your goal is to grow wealth. If, instead, you view active management as a source of entertainment, you may wish to consider less costly ways to amuse yourself.”

Study after study proves that active managers add no value to your portfolio. Investing for retirement is a long term process and a low cost, globally diversified portfolio, risk adjusted for you is the best option.

Please comment or call to discuss how this affects you.

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