Wednesday, March 01, 2017

The Optimism of Warren Buffett

Yesterday I quoted Warren Buffett regarding his skepticism regarding the performance hedge funds.  Buffett, however is not as dismissive of the American economy.  Below, and again from his latest annual Berkshire report are his optimistic comments and investment thoughts regarding the US economy.  Again, the highlights in it are mine:

"Our efforts to materially increase the normalized earnings of Berkshire will be aided – as they have been throughout our managerial tenure – by America’s economic dynamism. One word sums up our country’s achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.

You need not be an economist to understand how well our system has worked. Just look around you.  See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776. Starting from scratch, America has amassed wealth totaling $90 trillion.

It’s true, of course, that American owners of homes, autos and other assets have often borrowed heavily to finance their purchases. If an owner defaults, however, his or her asset does not disappear or lose its usefulness. Rather, ownership customarily passes to an American lending institution that then disposes of it to an American buyer. Our nation’s wealth remains intact. As Gertrude Stein put it, “Money is always there, but the pockets change.”

Above all, it’s our market system – an economic traffic cop ably directing capital, brains and labor –

that has created America’s abundance. This system has also been the primary factor in allocating rewards. Governmental redirection, through federal, state and local taxation, has in addition determined the distribution of a significant portion of the bounty.

America has, for example, decided that those citizens in their productive years should help both the old and the young. Such forms of aid – sometimes enshrined as “entitlements” – are generally thought of as applying to the aged. But don’t forget that four million American babies are born each year with an entitlement to a public education. That societal commitment, largely financed at the local level, costs about $150,000 per baby.  The annual cost totals more than $600 billion, which is about 3 1⁄ 2% of GDP.

However our wealth may be divided, the mind-boggling amounts you see around you belong almost

exclusively to Americans. Foreigners, of course, own or have claims on a modest portion of our wealth. Those holdings, however, are of little importance to our national balance sheet: Our citizens own assets abroad that are roughly comparable in value.

Early Americans, we should emphasize, were neither smarter nor more hard working than those people who toiled century after century before them. But those venturesome pioneers crafted a system that unleashed human potential, and their successors built upon it.

This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the

build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history.

America’s economic achievements have led to staggering profits for stockholders. During the 20th
century the Dow-Jones Industrials advanced from 66 to 11,497, a 17,320% capital gain that was materially boosted by steadily increasing dividends. The trend continues: By yearend 2016, the index had advanced a further 72%, to 19,763.

American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.  Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.

Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.

Back Friday. 

*Berkshire Hathaway is a component of several ETFs that we hold in client and personal accounts.  Certain client accounts hold legacy positions in ETFs representative of the Dow Jones Industrial Average.  We also invest in ETFs related to the S&P 500 in client and personal accounts although these and all positions can change without dissemination on this blog or on any other form of electronic media.  

Tuesday, February 28, 2017

Warren Buffet's Hedge Fund Bet

Warren Buffett was out with his annual letter to clients of Berkshire Hathaway this weekend and as always there are some wonderful investment insights to be garnered from either reading the whole thing or the highlights which you can find from any number of sources on the internet.  For example the website "Zero" highlighted the other day Buffett's skepticism of hedge funds, a view I have come to appreciate over time.  Below,  and almost verbatim I've shown Buffett's comments  regarding hedge funds and the bet he made on these ten years ago from his latest annual Berkshire report.  The highlights in it are mine.

"In Berkshire’s 2005 annual report, I argued that active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund. "

Subsequently, I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line? 

What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides –stepped up to my challenge. Ted was a co-manager of Protégé Partners, an asset manager that had raised money from limited partners to form a fund-of-funds – in other words, a fund that invests in multiple hedge funds. I hadn’t known Ted before our wager, but I like him and admire his willingness to put his money where his mouth was. He has been both straight-forward with me and meticulous in supplying all the data that both he and I have needed to monitor the bet. 

Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund. The five he selected had invested their money in more than 100 hedge funds, which meant that the overall performance of the funds-of-funds would not be distorted by the good or poor results of a single manager. Each fund-of-funds, of course, operated with a layer of fees that sat above the fees charged by the hedge funds in which it had invested. In this doubling-up arrangement, the larger fees were levied by the underlying hedge funds; each of the fund-of-funds imposed an additional fee for its presumed skills in selecting hedge-fund managers.

The results aren't pretty for active managers. The S&P 500 index fund has climbed 85.4% to date. Only one hedge fund of hedge funds came remotely close with a 62.8% return. The others are well below with gains of 8.7% 28.3% 2.9% 7.5%.  In annualized returns, the S&P 500 index fund returned 7.1%, while the five hedge fund of funds delivered through 2016 an average of just 2.2%."

The compounded annual increase to date for the index fund is 7.1%, which is a return that could easily prove typical for the stock market over time. That’s an important fact: A particularly weak nine years for the market over the lifetime of this bet would have probably helped the relative performance of the hedge funds, because many hold large “short” positions. Conversely, nine years of exceptionally high returns from stocks would have provided a tailwind for index funds.

Instead we operated in what I would call a “neutral” environment. In it, the five funds-of-funds

delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000.

Bear in mind that every one of the 100-plus managers of the underlying hedge funds had a huge

financial incentive to do his or her best. Moreover, the five funds-of-funds managers that Ted selected were similarly incentivized to select the best hedge-fund managers possible because the five were entitled to performance fees based on the results of the underlying funds.

I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”

The underlying hedge-fund managers in our bet received payments from their limited partners that
likely averaged a bit under the prevailing hedge-fund standard of “2 and 20,” meaning a 2% annual fixed fee, payable even when losses are huge, and 20% of profits with no clawback (if good years were followed by bad ones). Under this lopsided arrangement, a hedge fund operator’s ability to simply pile up assets under management has made many of these managers extraordinarily rich, even as their investments have performed poorly.

Still, we’re not through with fees. Remember, there were the fund-of-funds managers to be fed as well. These managers received an additional fixed amount that was usually set at 1% of assets. Then, despite the terrible overall record of the five funds-of-funds, some experienced a few good years and collected “performance” fees. Consequently, I estimate that over the nine-year period roughly 60% – gulp! – of all gains achieved by the five funds-of-funds were diverted to the two levels of managers. That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have effortlessly – and with virtually no cost – achieved on their own.

In my opinion, the disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the future. I laid out my reasons for that belief in a statement that was posted on the Long Bets website when the bet commenced (and that is still posted there). Here is what I asserted:

'Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.  A lot of very smart people set out to do better than average in securities markets. Call them active investors.  Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore, the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.'

*Berkshire Hathaway is a component of several ETFs that we hold in client and personal accounts.  We also invest in ETFs related to the S&P 500 in client and personal accounts although these positions can change without dissemination on this blog or on any other form of electronic media.  

Monday, February 27, 2017


"Merrill Lynch has lowered its top charge on fee-based accounts to 2.2% from 2.7%, a move that could save smaller investors as much as $5,000 a year, The Wall Street Journal reports.

The reduction affects clients with under $1 million in assets at the firm. Those clients with $1 million to $4.9 million in assets will continue to pay a maximum of 2.2%, while investors with $5 million or more in assets will continue to pay a top rate of 2%.

Last year, Merrill began a process of changing its brokerage accounts, making its fee structure more transparent and, in some cases, less expensive, the Journal story said."

Seriously folks if you are paying 2% to a brokerage firm for investment management you are paying way too much.  The average RIA charges about 1%.   Those returns from your broker better be really stellar to merit that kind of fee.  You can like your broker but you shouldn't have to pay him over a hundred basis points more than the RIA average for him to be your friend.

Link:  Merrill Lynch Cuts its Top Rate on Fee Accounts.

Thursday, February 23, 2017

Chart Talk {02.23.17}

Above is the current chart of the S&P 500 ETF, SPY.  The chart is from and you can double-click on it to make it larger if you would like a better view.   Today I would like to point out is what might have happened if you had listened to many of the investment or political pundits over the last nine months and let their advice determine the direction of your portfolio.  There's a trend here and I want you to pay attention.  What you hear on the news, read in the papers or see online is largely today reflecting a view that so far has been at odds with the market's behavior. First let's go back a bit in time.

Last summer as the vote over whether Great Britain would vote to stay in the European Union heated up, the media both here and over seas nearly all came out and stated what a disaster it would be if Great Britain left the Union.  Well they did vote to leave and globally it was a disaster....for about three trading days.  Both here and abroad markets rallied after the vote was cast.  Here from high to low over a two month stretch in the summer stocks rallied over 10%.  They weren't supposed to do that according to most of the experts.  Even if they did those same folks thought it was a sucker's bet and stocks would decline once investors realized the economic consequences of their decision.  Those folks are still waiting to be proven right.

Most of the same commentators felt the same way about our presidential elections back in November.  First off, most dismissed the possibility that candidate Trump could ever become President Trump.  Then they were sure it was going to be a disaster after Trump was elected President.  Instead the market has rallied almost 14% since then.  Stocks are also currently up now better than 4% since President Trump's inauguration.   

Now understand something.  Markets aren't up because investors necessarily love the President, voted for him or even agree with his policies.  The markets care about how his policies impact the economy.  In that regard, so far, the market's like what they are seeing.  They believe that an administration that advocates tax reform, repatriation of US assets abroad, less stifling regulation and a potential infrastructure spend are all positive for the economy.  As long as market's believe these things then stocks will stay on firmer footing.   Understand that markets are not making a judgement on some of Trump's social policies.  Markets for example don't care about transgendered bathroom issues, although individual investors likely have personal opinions about these things.  Rightly or wrongly, they care about economic returns and making money.  Folks who equate such things to the economy are missing the bigger picture as far as money and the markets.

Firmer footing does not mean we'll never see a correction or that stocks will continue on this kind of run.  Indeed right now markets are overbought and there is the hint of giddiness hitting investors that I haven't seen in ages.  That means stocks are vulnerable to and likely will have a correction at some point.  However, as long as investors believe the administration will continue to follow and be able to implement positive economic policies then corrections will likely be met with buyers at lower levels.  Investors will "buy the dips" on any pullback as long as their confidence in the administration's policies remains in place.

You will see little of this thought from most of American journalism or the opposition.  Our industrial media complex hates President Trump in a way that you have to go back to President Nixon to recall and the left hates him for many reasons.  One thing both fear is that his economic policies work ass that would be a repudiation of much of what each believes.  As a result they want him to fail.  As such they will portray nearly everything he does as evil and wrong.

I am not trying to endorse anyone's political position or critic what other people believe and I try to keep politics out of what I post here.  Indeed, there are aspects of the Trump Administration's policies I like and others that concern me.  I am a neutral in most aspects except those that can put our economy on a positive note.  Those kinds of policies I am for regardless of political affiliation.  The reason I have spent some time on the media is not to defend the President but to point out to readers here the disconnect between what's happening in the markets and what you may read in the press or see on the news.  Both increasingly try to portray the Trump Administration as a failure or an Administration that doesn't reflect American values.  Both ignore the market's performance and the millions who voted for the President.

Listening to the news since last summer would have cost you money.  It's as simple as that.

Back Monday.

*Long ETFs related to SPY in client and personal accounts although positions can change at any time without notice or dissemination on any other form of electronic media.

Tuesday, February 21, 2017

Do You Know Someone Who Could Use My Help?

As an RIA, my goal is to create portfolios designed how my clients want their money invested; the same way they would if they had the time or expertise to do so themselves. This serves as my firm’s guiding principle as we assist clients in defining, implementing, and managing a customized investment strategy focused on their personal financial objectives. 

There’s no greater feeling than helping clients reach their goals. I love knowing that I can add value to my clients’ lives. I’ve now been in this industry for nearly three decades and my passion for what I do has never wavered. I love the markets and the intellectual challenge of investing. I get the same feeling of excitement and wonder every morning when the markets open as I did when I first started in the business.

If you know someone who could benefit from my help, I invite you to share my information with them. You can send them this PDF file to learn more about my firm. Thanks for your continued support! 

Friday, February 17, 2017

Expense Ratios

I know I published this awhile back but I'm putting this up again because I still run into a belief amongst some folks that somehow mutual funds offer better value than ETFs in terms of costs.  Costs should not be one of the reasons to own mutual funds.  The chart above shows that the average mutual fund has costs that dwarf those of ETFs.  

Take for example US Equity ETFs vs their mutual fund counterparts.  It is the top line in each asset class.  For ETFs the average cost is about 40 basis points but the weighted average is just 16 basis points.  We'll use the weighted average because the ETF industry is dominated by a few major players with much lower costs than the whole universe.  In that example those 16 basis points run up against an average expense ratio for actively managed open-ended mutual funds of 130 basis points.  Folks that's over 8x the cost for a product that usually doesn't do as well as the ETF.

There may be reasons to own mutual funds but cost isn't one of them.

Back early next week.

Wednesday, February 15, 2017

What's A College Degree Worth

Student loans represent an incredible burden on young people but at least the debt if applied wisely has a purpose.  It is what I call investment debt.  It is debt a person invests in themselves that hopefully earns a return over their lives.  Above you can see expected lifetime earnings for each degree that a person earns.  Somebody with a masters or doctoral degree earns over three times what somebody that leaves high school without a degree can expect to earn over their lifetimes.  

In that instance, and for example, a student completing a graduate degree could finish with $200,000 in student loan debt.  Assuming they possibly taking 30 years to pay off the loan and even with amassing perhaps $400,000 in total costs after the interest is paid would still see a return on their investment of many times over their cost.  

Back Friday.

Tuesday, February 14, 2017

Student Loans {Some Resources}

Here are some  resources to get more information on student loans and their repayment.

New York Times: "A Beginner's Guide to Repaying Student Loans.

Here's again the link to the New York Time's student loan calculator.  "Seven Federal Student Loan Payback Plans:  What You Need To Know."  "Find the Best Student Loan Repayment Plan for You."

Email me if you find other and better resources and I'll put these up on the blog.

Thursday, February 09, 2017

Chart Talk {02.10.17}

Above is the current chart of the S&P 500 ETF, SPY.  The chart is from and you can double-click on it to make it larger if you would like a better view.  There are a couple of things to note here.  The last time we looked at the index was about a month ago and SPY had been consolidating in a trading range shown since then.  You can see that in the chart between those two red horizontal lines near the north-east corner.   We broke out of that range a few week ago and have since traded in an even narrower range defined by that smaller green line above.  We're testing the top end of that range as I'm writing this. 

Similarly to our thoughts last month, we'll have to see whether this action represents some sort of topping pattern to the major indices or is simply a pause from which we again break  forward to new highs.  Only time and more economic data is going to give us the answer to that question.  We are also currently overbought by our work but not to the extent we were last month before we broke to new highs.

Also as I'm writing this they're saying on the TV that the S&P 500 is now up six out of the last seven days.

Back next Tuesday.  I'm in and out seeing clients next week so posting will be a bit light.

*Long ETFs related to SPY in client and personal accounts although positions can change at any time without notice or dissemination on any other form of electronic media.

Wednesday, February 08, 2017

Chart Talk: Student Loans.

From Zero regarding the rise of student loan debt:

"But while US consumers may have stepped back from a credit-card funded splurge in the last month of 2016, the far more troubling trend in student and auto loans remains, and as the following chart shows, as of Q4, both car and student debt hit all time highs of $1.407 trillion and $1.11 trillion, respectively."

I don't want to discuss car loans but that $1.407 trillion in student loan debt is a number we all need to bring into focus.  On one hand you can argue that student loans pay for themselves down the road in higher wages for a young person graduating from college.  I agree with that.  The average student loan I think is something like $30-35,000.  {I didn't have time today to go find the most commonly accepted number.  For this posting let's just accept this is close to the mark.}  Basically at that level you have a degree that hopefully pays for itself throughout a person's lifetime for the price of a decent new car.  

But those basic numbers  may not true for the kid who finances his way through four years of a private college.  That person may be looking at over $100,000 in debt.  A student financing their way through graduate school is shouldering even more of a debt burden.  I've talked to young people leaving graduate school with $200-300,000 in debt.  Taking a 30 year period to pay off that load means hundreds of thousands of dollars paid out in interest and all of that money being paid back to banks that isn't being spent out in the economy.

In fact take a look at that $1.4 trillion dollar number.  All of that is money that is either being paid back or will be paid back over the next 30 years or so.  Now you can argue that banks simply recycle a large part of those payments back into the economy and you would be correct.  But that number also represents money that isn't being spent on everything, homes, vacations, you name it. 

You want to get our economy back on track, then figure out three things.  Figure out how to lower the cost of a college education for most kids.  Figure out a better way to pay for it than we have today and then figure out a way to reduce the debt burden of this current generation of students either going through the system or who have recently passed through it.

Out Today

I will be out today attending several meetings and then I get to go in for the old annual physical.

Back tomorrow!  Hopefully in a better mood after being poked and prodded by the medical world!