Archive for August, 2011

This and That: Stock Markets, Lotteries and more…

August 4, 2011


It’s déjà-vu all over again. After rallying relentlessly from the market bottom of March 2009, stock markets have been beating a retreat for the past couple of weeks. Today alone, S&P 500 dropped 4.78%, the TSX Composite dropped 3.4% and stock markets across the globe experienced similar losses. Note however that bonds rallied and the drop in the Canadian dollar somewhat cushioned the fall in the US market. As an aside isn’t it funny how the investors seek refuge in the US dollar at the first hint of trouble?

What should investors do now? The answer as in the past remains the same (see Stock Market Recovery: What to do Now?, August 3, 2009, Japan Earthquake: What to do Now, March 16, 2011 and Greek Woes: What to do Now?, April 27, 2010): stay the course with the proviso that you have a sensible plan to begin with because nobody knows what tomorrow will bring. This could be the start of a bear market à la 2008-09 or a false alarm à la the summer of 2010. Unfortunately, nobody knows (though many pretend they do) and those who really do aren’t about to tell us.

  1. The Boston Globe reported an interesting story on how a small group of people exploited a loophole in the Massachusetts State Lottery to earn impressive profits. Now that the story is widely published, the State has introduced new rules to limit lottery sales in stores and plans to eventually shut it down.
  2. Jon Chevreau says that if you want excitement go to Las Vegas. Investing should be boring and dull.
  3. Unfortunately, says The Blunt Bean Counter, many investors crave excitement from their portfolios. I personally don’t find passive portfolios boring at all. The markets dived 50% in 2008-09 and pretty much doubled from the lows. That’s plenty of excitement for me, thank you very much.
  4. Ellen Roseman visits Teksavvy, a company that exclusively employs Canadians, offers an alternative to Bell and Rogers. Based on my experience with them so far, I have to say I have no complaints on Teksavvy either.
  5. Larry MacDonald wrote about a new study that says pension funds that actively invest 75% to 85% of their portfolios on average are able to beat the market. I haven’t read the paper but Larry Swedroe points to studies in The Quest for Alpha that pension funds do not beat their benchmarks.
  6. Michael James points out that unlike other walks of life, working hard offers no guarantee of success when it comes to investing.
  7. Canadian Financial Stuff says that even staycations are pretty expensive these days.
  8. Steadyhand’s Scott Ronalds recently wrote about a wrap product that held 18 mutual funds managed by 13 different managers. What’s next? A Total Mutual Fund Market fund that holds every mutual fund in Canada?
  9. Retire Happy Blog’s Jim Yih points out that since mutual funds trail their benchmarks, investors should ask themselves whether they are receiving value for the fees they are paying.
  10. A recent widow grappling with whether to receive a defined benefit pension or transfer out the commuted value received some valuable suggestions on the Canadian Money Forum.
  11. Million Dollar Journey featured a handy post on the US dollar credit cards in Canada.

David Dreman on Tactical Asset Allocation

August 4, 2011


Some investors advocate tactical asset allocation (TAA) or the practice of adjusting the portfolio mix of stocks, bonds and cash to economic and/or market conditions. In his book Contrarian Investment Strategies, David Dreman notes that while it’s true that an investor who could successfully TAA could grow money on trees, TAA is difficult to practice because “real market movements give dozens of signals, madly flashing buy, sell and hold all at once”. Mr. Dreman then compares the performance of mutual funds that employ TAA to their benchmark and finds the results disappointing.

Does it work? The figures are not encouraging. Figure 3-1, taken from Lipper and Morningstar data, shows the returns of 186 asset allocators for the 12 years to September 1997 compared to the S&P 500 and the average of all domestic equity funds. The period covers a good part of the bull market, as well as the 1987 crash, and the sharp downturn in 1990. This was the ideal time for market timers or asset allocators to prove their mettle. They should have got you out before the 1987 and 1990 debacles and back in on time to ride the resurgent bull. Had they succeeded, you would have outperformed the market handily.

As the chart shows, heroes they ain’t. While the market surged 734% over the entire period, and the average equity fund moved by 589%, the asset allocators increased only 384%, about half the gain of the averages (all figures are dividend adjusted). Tactical asset allocation has obviously not set the world on fire. In fact, it’s downright awful, even in the periods where asset allocators claimed they swept the field.

The prosecution rests.

Beating up on Couch Potatoes

August 2, 2011


In a recent post titled Why this is no market for Couch Potatoes, Balance Junkie took issue with a recent column in MoneySense magazine (See A cure for Potato performance anxiety, June 2011). In his magazine column, Canadian Couch Potato argued that passive investors should stick with their plan even though index portfolio returns in the recent past were rather modest. The Global Couch Potato composed of 40% bonds and 20% each in Canadian stocks, US and EAFE stocks returned 4.0% (or 1.2% in inflation-adjusted terms) in the 2001-10 time period. The irony here is that most average investors I know would look at their own portfolios devastated by expenses and performance chasing and gladly take 4% over the past 10 years. Still, Balance Junkie says that in a secular bear market, a Couch Potato strategy is not effective:

I have written over and over again that we are in a secular bear market that began in 2000. If you took that into account, you wouldn’t be at all surprised to see below-average returns for the Couch Potato portfolio over the last decade. The 20-year period before 2000 was a secular bull market. The Couch Potato approach would have worked beautifully during that time period, but it won’t be effective in a secular bear market.

First, it is not true that all Couch Potatoes are invested 100% in stocks all the time. As a (relatively) young investor with a spouse who has one of those nice defined benefit pension plans, we have a 20% allocation to bonds in our retirement accounts but an older, retired Couch Potato might have 100% in bonds. The point is a Couch Potato takes risks she is able and willing to take.

It should also be hardly surprising that investors with the bulk of their funds in the stock market experience poor returns from time to time. For instance, in the 10-year period 1973 to 1982, the Global Couch Potato would have returned 9.43%. That sounds great, except that the returns work out to just 0.85% in real terms. (And just an aside, a Couch Potato who persisted with the strategy would have earned 9.67% in real terms over the next decade). It is true that an investor who can nimbly move out of assets before they start underperforming and into assets before they start outperforming can do much better. There is only one little problem: the average, retail investor has pretty much zero chance of doing it consistently (and the record of professionals after fees and expenses isn’t anything to write about either).

Third, a well-diversified Couch Potato already takes advantage of market fluctuations by rebalancing her portfolio. Anyone can pull up a long-term chart and see for themselves that stock returns (at least in certain markets) since 2000 haven’t been great. It is much harder to correctly anticipate market conditions and adjust one’s portfolio accordingly. So, those who aren’t happy with Couch Potato returns should ask themselves: Were my returns any better? Was it skill or merely luck?