Judo originated in the late 19th century and can be translated as “the gentle way.”  There are no punches or kicks in Judo.  It’s about transferring energy efficiently.  While throwing someone might take a lot of energy to the untrained, it could be virtually effortless to a Judo practitioner.  In the book Rework, the author mentions Judo and applies the thought to making work more efficient.  I can’t help but see how this applies to portfolio management too.  How do we achieve maximum benefits in the most efficient manner?

A portfolio of index funds that provides ownership in companies around the world can be accessed by anyone.  It’s not as difficult as it may sound.  Add in high quality and short- to intermediate-term fixed income, and then you can start managing risk even better.  The point is to keep this portfolio in a healthy balance, and to continue adding to your positions over time.  Using asset allocation and index funds is probably the most cost effective way to invest, and over the long-term, we believe that it is the most efficient way of capturing all of the returns that markets provide.  Plus, by staying invested, and by biasing the portfolio to small and value stocks, we believe that return premiums can be added while increases in risk can be mitigated.

At the end of the day, wouldn’t it be more efficient to have your money working for you in a smart way?  A few simple steps can have a big impact, and with the right training, successfully managing your portfolio can become effortless.

I enjoy reading the Wall Street Journal, but that does not excuse them from our media scrutiny.  Below is an ad pulled from today’s paper.  I can’t help but take issue with their angle.  Fundamentally, investors are looking to maximize returns and lower their risk.  Seems to me that there is low-hanging fruit to be had, and it’s the natural return premiums earned over time with a globally diversified market portfolio.

Knowledge is power - Yes, I tend to agree; however, knowledge of capital markets is not the ability to forecast interest rates, or the attempt to know about every merger and acquisition before the public - which is a waste of time and energy.  As a student I worked in the kitchen of a very large corporate restaurant group.  It was grueling work that required a strong back and thick skin.  One day, the VP of the group, who was a chef, advised me to “work smarter, not harder.”  Anyone can break their back, but all that does is put you out of commission.

Do you need the Professional Edition with SmartSearch and Factiva, whatever that is?  I would say that if you need a magnifying glass to find the high-hanging fruit, then you’re better off taking the ripe and juicy, low-hanging fruit.  If high-hanging fruit means spending all day and night doing quantitative analysis, and researching news articles to piece together a mosaic theory, then I’m sorry, but you’ve wasted your time, your money, and possibly your sanity.

Make your money work smarter for you; don’t work harder for your money.  Especially if working harder actually puts you at risk of losing more of your money.  Diversify across a global mix of asset classes, an appropriate mix of fixed income and equity, and tilt your equity to small cap and value.  Earn everything that the market naturally provides and capture the premiums where they exist.

The argument between passive and active fund managers is an old debate.  Each side collects data to state their case, talks a little trash, and goes on with business as usual.  Something to keep in mind is that active funds cannot always be compared, apples-to-apples, against a benchmark index.  Here’s a Wall Street Journal article by Jason Zweig that digs right into this issue, and addresses why it’s not always fair to compare an active fund against even the closest looking index.

We’ve said it before, and I think that probably 95% of investment professionals, if not more, started their careers fancying themselves as stock pickers (i.e., an active manager).  This is because finance students are taught quantitative analysis, economics, and so forth - all while keeping a personal eye towards taking these skills and realizing the ambitions dreamt during the cash poor days of college life.  At some point, one either realizes that consistently successful active management is a myth to lure new clients, and that those myths do nothing for one’s ethical sense of responsibility; or, they find the salesman approach works for them.  Some even believe they are doing their client’s great service.

Passive investing may not always win in the short-term, but in longer time periods, it becomes more obvious that a passive strategy keeps costs low (thus taking away less from returns), and delivers a more consistent experience that ultimately sets the stage for average returns to have a better chance of cumulating into a higher long-term total return.

The graph below looks at one-year, three-year, and five-year passive index outperformance of active funds.  What this shows is how many actively managed funds were beaten by a simple passive index fund, over different time periods.  Having an aggressive portfolio does not have to mean having a poorly managed portfolio of concentrated stocks, or an actively managed portfolio.  It should mean being passively aggressive in your allocation and portfolio structure to capture all of the systematic risk benefits, while lowering your costs (thus adding to your returns).

Bullfighters use a red cape to throw off the crosshairs of a charging bull.  Superman used a red cape for high fashion and ocassional protection.  For investors, confidence has been dragged through the mud and left for the vultures.  Sometimes it seems like the only red cape that investors have is the one luring us to be stuck with spears.  How can we be fashionably protected?  It’s not about knowing what the market will do or what will serve as a hedge against the unknown.  I almost hate to say it because it seems so cliche, but knowledge is power.  When we understand how efficient capital markets work, then we find that there is no inflation-retardant, interest rate-predicting red cape that can save our portfolios.  There are many variables for successful investing, but there are three that just have to be drilled into our heads: Time, Discipline, and understanding Efficient Markets.

The market has improved by leaps and bounds.  From the S&P 500 high of just over 1500 in mid-2007, it dropped 55% to 667 in early March of 2009.  Since that trough, the S&P 500 is up around 75%, closing at 1170 as of yesterday.  The S&P 500 is still 22% off it’s high.  If efficient markets are an indication of investor confidence, then it appears that investors are heads up and shoulders back.  Cross-hairs seem to be refocused on true goals, and the experience of the last two years can be catalogued at the front of our financial minds.  We set our expectations based upon our experience and knowledge, and in long-term investing it’s critical that we see the forest for the trees.

In a follow-up to our last entry, we’d like to pose a forecasting question?  What will be the fate of Ebullio Capital Management’s hedge fund after their latest news release?

Ebullio’s commodity hedge fund fell 86% just last month!  That’s staggering.  They’ve gone from managing $42.3 million last November to $1.47 million.  To be fair, the fund has earned large positive returns in past years, and as result have earned a healthy 2% management fee from their clients.  They just waived their 2010 fee.  It looks to us like they’re playing games with client money.

Volatility is a natural part of capital markets.  Do we need fund managers to add more risk and volatility?  And, do we need them to add this risk while they ultimately know nothing of your financial goals and situation?  The answer is no.  If you earn 92% in a year, and then 29% the next year, what good is that if you then lose 86% in a month?  We could ask the Ebullio hedge fund clients, because that’s what happened to them.  Investing doesn’t have to be a roller coaster.  The experience can be smooth and you can enjoy your life without having to worry too much about your investment portfolio.

It’s not always about beating the Jones’.    Sometimes it’s just about earning a consistently average return while others are bouncing out of control all around you.

When you receive the kiss of death from the godfather, you know it’s time to run for the hills. When you’re a hedge fund investor and your hedge fund is getting publicity, it may also be time to get out if you can.

In a study done by the CXO Advisory Group, 80,000 searches on Google and monthly return data from 978 hedge funds were used to determine the impact that media coverage has on hedge fund performance. The findings are that hedge funds with little to no media coverage outperformed their more highly covered hedge fund competitors over the 18 months after at least one news item. The researchers found that no-coverage hedge funds beat the media-coverage hedge funds by 3.5% annually from 1999-2008. It was also noted that a media covered hedge fund had an 80% chance of being covered again the next month.

Take this all with a grain of salt. The time period is a bit short to be conclusive. We’ve harped about media and how it tends to be so noisy  that it negatively influences investor behavior.  Now, it is interesting to see media’s negative impact on hedge fund returns.

I don’t want to be kissed by the mafia don, and apparently, I don’t want to own a hedge fund that is getting media coverage. It seems like the simple portfolio solution is also the best - just own a market portfolio that’s diversified across a proper mix of global equities and fixed income that matches one’s risk tolerance and gives the best chance to achieve financial goals.

Here’s what the Kiss of Death looks like so that you can be sure to pack your lifejacket and skip town.

Greece isn’t actually the focus of today’s blog. I just wanted an amusing title for a blog about the sovereign risk of nations and how such risk impacts investors. I’m easily amused, I admit.

A year and a half ago, major banking institutions were carrying debts so large that governments began to bail them out and transfer the banks’ debts to the governments’ balance sheets. Now that these debts have moved, investors have been concerned that the recessions felt throughout the world are compounding the burden upon those nations. This concern comes about because no investment is truly risk-free. Even the power to print money has not prevented all overextended sovereign borrowers from defaulting.

Taking on risk should have rewards, but concentrating risk can penalize you so much that the rewards are minimized. Much of this has to do with the timing of returns, and since no-one knows the future, taking on concentrated risk can be quite destructive to your portfolio.

Diversification is a common mandate, but diversification requires different things for equity and fixed income. To diversify globally within fixed income involves allocating across sovereign, supra-national and corporate debts, but also limiting exposure to any single issuer, and restricting the eligibility of certain countries of risk. At the next level, diversification can mean spreading fixed income allocations across different credit qualities and maturities.

The core of our fixed income approach is to use high quality, short-term fixed income that is diversified globally. The reasons for this are many, but fundamentally we view fixed income as a way to reduce overall risk. Through additional enhancements made last year, we looked to improve potential returns while increasing diversification and maintaining a similar risk profile. Our process is not to predict the future, but rather, to prepare for what may come by having a well designed portfolio. Good investing is based upon sound philosophies and should not be a reactive process.

March 9, 2009 marked the low point of the S&P 500, when the broad market US index closed at its trough of 667. One-year has now passed and as of yesterday, the S&P 500 is up 70.6%. With all of the naysayers, doomsayers, and pessimists littering investment media over the last year, confidence has been particularly difficult to maintain. On this anniversary date, we’re quite satisfied to know that our investors stayed true to their beliefs, and despite the economic hardships, remained disciplined in our investment approach and captured the returns that the markets provided.

A year ago, the general themes of media headlines were along the lines of someone asking for billions of dollars, crimes of fraud, troubled assets, nervous investors, unstable interest rates, downgraded companies, and shaky worldwide economies. News these days have become a bit less dramatic, and with the strong returns of the last year, it is no wonder that many investors would rather turn a somewhat-relieved blind eye to the economy. Yet, while we encourage removing the noise from investment advice, we also encourage understanding the environment. In a nutshell, what this means is recognizing the randomness of returns. Neither positive nor negative returns will persist forever, and as investors we must keep in mind that returns are random. For peace of mind, our expectations must be hedged with understanding of the long-term strategy.

A year has gone by with substantial positive returns, and for that we can enjoy this anniversary.  A once in a lifetime lesson in investing, finance, and economics has been taught to us all, and for that we can be more wise.

The line between successful and unsuccessful investing can be quite thin. Given all of the same circumstances, what often determines successful investing is typically the willingness to stick to the philosophy and the ability to rise above the noise.

It has been a while since we’ve posted anything.  So I thought we’d ease our way back into things.  Just the numbers today.  February was a good month, with US equities posting slight positive returns.  Despite the poor economic news and general state of concern, US stock markets performed well.  Of course, one month’s data is not enough to make a case.  In reviewing 10-year annualized returns, we are not surprised to see that Small Cap and Value indexes outperformed Large Cap and Growth indexes.  As always, our stance is that one should be invested across a well-diversified portfolio, and that by tilting the allocation towards Small and Value equities, one can earn greater return premiums than by staying invested in growth equities.

In investment-related media, every year begins in a similar way.  Forecasts are made and then indexes do what they will.  Enter a search on “2010 stock forecasts,” and see what you find.  Or, just keep an eye out in just about every investment-related publication.  We understand that analysts have to make a living.  We also know that some of them will get lucky.  We just don’t believe that luck is a good enough foundation for your financial future.

The S&P 500 closed 20% up for 2009, which effectively debunked many early 2009 predictions.  Here’s a BlackRock prediction that called for a 7 to 12% market increase.  At least they called for a general market rise, as opposed to picking individual stock movements, and at least they got the general direction correct.

Here are our predictions for 2010, and beyond:

1. Annual January predictions for stocks, sectors, asset classes, and the market as a whole (domestic and global) will continue to be popular.
2. Markets will not be consistently and accurately predicted.
3. Volatility will remain a natural part of investing.
4. Returns of asset classes will be random