Counterintuitive Is Not Just A Cool-Sounding Word.

It is the way to describe many of our best investment choices right now. With stock markets in volatile moods and economies on the ropes, investors are wondering where to invest. Bonds. That's usually the call when stocks get too scary.

But bonds are not always safe. The better-quality bonds do pay you back your money, with interest, but if you need your money back before the bond matures, you can make or lose money. Sometimes a lot.

When interest rates sink, such as during a recession when central banks want it to be easier for businesses and individuals to borrow money (to hopefully stimulate the economy), the price of bonds you hold will go up if the interest rate you have is better than what newly-issued bonds would offer. The reverse is true when things are going perhaps too well economically and the central banks decide to slow things down a bit.

Well, rates also rise by accident, when things are bad--not just when they're too good. If a usually economically-sound country keeps issuing bonds to pay for government services that are not funded well enough by tax revenue, that indicates to investors that the country might be facing difficulty. Between that and an increased supply of new bond issues, the demand/supply ratio is affected. When there are not enough buyers, sellers either lower their prices or sweeten the pot. Offering higher yields is the sweetening the pot, and selling for less than face-value (the earlier scenario) is the lowering of the price.

If the USA is taking on massive amounts more debt, there's a leveraging of the increase in yield it must offer to attract investors. That pushes down the value of the bonds one might already hold... and that's the kind of nest egg damage a lot of folks seek to avoid when they go into bonds in the first place.

So, what to do?

Interview with A Fund Manager: Matt McLennan, First Eagle Global Fund

Here is an interview with one of the two co-managers of one of the best global/flexible mutual funds on the planet. The fund tries to deliver good returns in good markets while protecting against the downside during bad markets. It is quite effective.

*down only 21% in 2008 (the foreign stock market was down 41%, the US down 37%)

*up 23% in 2009 (vs. up 27% for both Foreign and US).

*up over 7% per year for the past 5 years (the foreign market was up just 1% per year, the US market was almost exactly break-even).

Cut/paste the link below here to see the interview (I'll try figure out how to post links soon):

http://www.executiveinterviews.net/players/mini/default.asp?order=U13259

Double-dip Recession, or Just a Market Correction?

The Bad News...

European banks are starting to not lend to each other... reminds us a lot of the USA in late-2008.

The spread between junk bonds and treasuries has jumped 200 basis-points, indicating possible "contagion" here from Europe's troubles.

The stock markets are tanking lately.


The Good News...

The rising dollar has pushed down energy prices, which is a boost to the U.S. economy. It's like getting a decent-sized tax cut, some have pointed out.

Interest rates remain low, which helps troubled homeowners and lending banks that need time.

This is probably just a "correction", and so we can buy some good stocks "on sale" this week.


What We Think...

We hate to be pessimistic, but our long-term view is just that. We think the governments of the developed economies will fight-off disaster (another "Great Recession") but the tools used will be impediments to growth.

Avoiding that double-dip would inspire markets, though. Interest rates are so low and there's a ton of cash on the sidelines. Stocks have a lot of potential in the short term. But be flexible.

Thinking Out of the Box, Literally: What About the Style Boxes?

In our last post, we met the Style Boxes. If you missed it, please read that and then come back here.

2008 was an unfortunate but inevitable example of how sticking with strategic allocation to a variety of style boxes can sometimes be of little help in avoiding portfolio declines during a "crash". And 2009 similarly showed us how sticking with our selected style boxes can keep us out of the best performing areas of the market in an big "up" year.

Portfolios that utilize a global/flexible approach, though, can offer much better returns. Or much bigger losses. It really depends on whether the manager of a global/flexible fund, the advisor running a client's portfolio, or an individual investor picks the "right" style boxes to emphasize and avoid.

This tactical allocation is more art than science, whereas the strategic allocation is more science than art. It is clear, though, that managers with long-term track records of "success" using global/flexible or tactical methods have significantly out-performed "the market" and portfolios using just strategic asset allocation.

Some examples:

A global/flexible mutual fund we love uses both strategic and tactical methods at the same time. It is usually about 60-40 stocks-bonds, and 60-40 domestic-foreign. Within the stock allocation, though, it can go anywhere it wants, and same within the bond allocation. For example, if 36% of the portfolio is to be in U.S. stocks, but the manager is wary of small-cap growth stocks and strongly favors large-cap value, he can direct the entire 36% to that style box. This fund was down only 21% in 2008 (the US market was down 37% and the foreign-developed stock market was down 43%), and it averaged over 7% per year over the past decade while the U.S. market has been at about -1% per year. This fund has a 21 year track record and has always delivered like this. Clearly, they know better than most where to be and when.

Another global/flexible mutual fund we love can go anywhere and invest in just about anything. At the worst of the 2008 crash, it was only 15% in stocks and had taken large positions in cash, gold and bonds. During the big run-up in 2009 it was around 80% in stocks. It was only down 26% in 2008, and it's 10-year track record is over 10% per year.

Still another fund we love was only down 8% in 2009, and it's averaging almost 9% per year for the last decade. This one doesn't move around the style boxes so much as it invests significantly in areas outside of the normal style boxes.

These global/flexible funds are the exception; most who try don't succeed at beating the market for very long. But they are out there, folks. You just need to know how to get 'em. Or you need an advisor to find them for you.

Thinking Out of the Box, Literally: Introducing the Style Boxes

In an earlier post, I said investors and their advisors should be thinking out of the box right now, and I meant it literally. But it was industry insider lingo, so I'll explain it more in this post and the next one over the weekend. For now, let's meet the "style boxes".

Each investment style box represents a particular slice of the investment marketplace. Picture a tic-tac-toe board. The top boxes, if we're talking about stocks, are for the large companies. The top-left box is for large "value" companies. Top-right is for large "growth" companies. The top-middle box is for large "blend" companies.

The middle row is for the mid-size companies, the bottom row for small companies. And a similar board full of style boxes can be made for companies outside the U.S., in either "developed" markets or "emerging" markets.

Same story for bonds, but the categories are different: high, medium and low quality... short, intermediate, and long duration... government (aka sovereign), municipal, and corporate... domestic, developed-foreign, and emerging markets...

Okay, so what?

Well, a typical mutual fund or private portfolio manager invests pretty much in just one style box, or maybe a few very closely-related style boxes. Since different investment styles do better or worse at different times, it is important to either allocate your portfolio to the right long-term strategic mix of style-boxes or to be able to move out of the style boxes that are going to have difficulty and into to the ones that will do well, and then back again when conditions dictate.

In 2008, all but a few style boxes were bad places to be invested. Almost everything was going down, a lot. Even the best strategic asset allocations got hammered. There is Nobel Prize-winning research showing us how much to put in and keep in which style boxes for the long-haul, and it's valid. But it was very painful in 2008 to have stayed with a strategic asset allocation because you were deliberately staying put in style boxes that were plummeting.

It could be painful like that again sooner or later, given the fundamental economic difficulties much of the developed-world economies have right now.

So, next we'll talk about ways to think and move out of "the box(es)". It might be helpful.

A Volatile Market

So, the stock markets were up today on pretty heavy volume. That's as good news today as it closing down on heavy volume was bad news yesterday.

There are a ton of competing indicators, so it's very tough to know what to expect. One thing is certain, though: the financial health of many of the economically developed countries is in jeopardy from unhealthy balance sheets (translation: the big, strong countries are in trouble because they're spending much more than they're bringing in, and the solutions are to cut services to people who need them and raise taxes on the people who are most productive in the first place).

This is not inherently a positive long-term situation for the stock markets, and it also jeopardizes the bond markets.

Investors and their advisors should probably be flexible and thinking out of the box. More on that later.

Happy Friday, and a great weekend to you!

Pullback, Correction, Bear Market, Crash???

Lots of market lingo gets tossed around. Here's my effort to clarify it for you:

A "pullback" is when a securities market declines up to 10% from its recent high-water mark. It may happen in a few days or even a few weeks. It's usually because the market was going up faster/higher than it should, but it usually does not signal any major problems. Long-term and opportunistic investors enjoy a pullback once in a while, as their Buy List securities are effectively "on sale".

A "correction" is when the market experiences an extended pullback, ending up 10% or more below the most recent high-water mark. This is where things get worrisome--perhaps there are real problems and the market is starting to price accordingly.

A "bear market" is much worse. It usually happens when a pullback or a correction turns out to have been due to economic fundamentals instead of just market action. 20% down from the recent high is the threshold. Long-term and opportunistic investors still like bear markets, though, as they feel great bargains are available.

A "crash" is when we speed right through pullback and correction status and into bear market range much faster than usual. A crash can be short-lived, like in the fall of 1987 or the fall of 2008, after which a sharp recovery can take place. A crash also can be the start of a long, drawn-out period of terrible market conditions like during the "Great Depression" of the 1930s.


We are in a correction right now. Many experts predict it's a bear market in the making. Those experts are often wrong, but they are also often right. Sometimes the market does not do what we think it should.

Diversify Your Portfolio, But How?

We are wise to not put all our investment eggs in one basket. Enron went bankrupt nearly a decade ago. It had been one of the very most highly-regarded businesses and stocks on the planet, until it suddenly wasn't.

Mutual funds, Separately Managed Accounts, Exchange-Traded Funds, and Unit Investment Trusts all offer convenient ways for investors to diversify their portfolios and avoid Enron-like debacles. They also offer the chance to make use of professional portfolio managers who can/should know a lot more about how to invest than the average person.

In addition to choosing which type of product to use, though, a prudent investor must determine which of the sometimes thousands of choices within a product category are worth using. Owning a mutual fund might offer more diversification than you would get for yourself, but it should also be "better" diversification.

It is a good idea to hire a trusted and knowledgeable advisor to help you decide what products to use, and especially to find the best providers of the chosen product type. You can do it yourself, of course, but make sure you have the time and tools and discipline to do it well.

All That Gold Isn't Always Glitter

Gold. Popular now. Likely to rise in coming years as currencies devalue, inflation returns, and instability spreads.

BUT GOLD IS NOT INHERENTLY SAFE. Gold is a volatile commodity. It's way up from where it was years ago, but that was way down from where it had been.

Invest in gold if you think it's going up. Do not invest in gold as an alternative to cash.

Cost vs. Cost-Justification

Most of us want to save money wherever we can, but blindly pursuing low-cost investments, such as index mutual funds or exchange-traded funds, can be costly. As with many of life's matters, investments should be more about cost-justification than simply cost.

To be sure, most investors are better-off using index funds or "ETFs" instead of actively-managed funds, since most of the latter underperform their benchmarks over the long-haul, and the benchmarks can be "had" via an index fund or an ETF.

However, savvy investors, or investors aided by diligent financial advisors or brokers, can find the mutual funds that have consistently and significantly outperformed their benchmarks on a risk-adjusted and cost-justified basis.

In short, if you can find a fund that does 3% per year better than your index fund, only charges 1% more per year, and has about the same risk measurements, wouldn't you rather have that extra 2% per year of growth?

Index Funds, If You Must

"I am in an index fund, so I'm just fine," you may think. But you may be wrong!

See, there are Domestic, Foreign and Emerging Markets stocks, and among them are Large, Medium, and Small companies, and each is likely of either the "growth" or "value" variety. On top of that, there are more than a dozen types of bonds. But each "index fund" usually only picks ONE of all those categories.

Investors should use a variety of index funds in order to balance risk and reward. But which index funds, and how much to put into each, are questions usually best answered by a professional. So, before you rest easy about your index fund, you should talk to a pro.

"Broker" vs. "Advisor"

An investment advisor has a fiduciary obligation to its clients to act in their best interests, and that obligation remains active throughout the advisor-client relationship. A broker simply needs to make suitable recommendations at the time of purchase or sale of investments.


If you know what you want to invest in and just need a professional to facilitate the transactions, a broker is a good choice. If you have time to enter the transactions and conduct your own due diligence, then an online or discount broker is an even better choice.


If you are not sure what to invest in, or how to evaluate the types of investments you want, or if you want personal financial advice to complement or guide your investments, an investment advisor is a good choice.


(UPDATE February 2015, in light of President Obama's push to bring "brokers" up from the "suitability" standard to the "fiduciary" standard)...


As the owner and sole employee of a Registered Investment Advisor-type firm, I am always serving in the advisory capacity with a fiduciary responsibility to my clients.  When I was a "financial advisor" at Morgan Stanley and then A.G. Edwards/Wachovia Securities/Wells Fargo Advisors, I was serving in a broker capacity with merely a suitability requirement, unless I was using the firms' "advisory" products that required me to adhere to the fiduciary standard.  I did the latter most of the time, and some clients understood that while others did not (even when I tried to explain the difference), and that is hopefully the real issue the Administration is now trying to address.  I hope they are not simply going after financial professionals in general.


An example of how the brokerage and advisory roles differ, and how different financial services professionals could/may/do operate, here's a little story from my early years (spoiler alert:  I did the right thing but got paid a lot less)...


A client came looking to invest $600k in an annuity, which is a complicated insurance product with investment features.  Morgan Stanley, my employer at the time and where I was serving in a brokerage capacity, offered variable annuities and fixed annuities, the latter having more guarantees, the former having more upside potential.  Either one was suitable for the client, but the fixed annuity was the better fit.  Morgan Stanley presumably made more money on the variable annuity products, as they paid us 40% of the commission on those, compared to just 10% of the commission on the fixed annuity products.


The client liked both ideas and left it up to me.  With either product, the commission was NOT taken out of the investment directly--the client's $600k would all be in the account on Day Two.  In a way, my choice was $9600 paycheck or $2400 paycheck.  Based on the suitability standard governing brokerage employees like me, I could have sold the variable annuity and made more money.  But I believed the fixed annuity was a better fit for the client.  So that is what I recommended and sold, and I left $7200 on the table despite no requirement to do so...


If the government is trying to make it so more financial professionals have a higher standard to uphold, I can live with that.  If new regulations are going to make it harder for "advisors" already subject to the fiduciary standards to find and keep clients, I will be unhappy--for myself and the mass-affluent and emerging-affluent Americans who really need my kind of help.