The Permanent Portfolio, Investing, Finance and Random Thoughts.
Investing
Investing
Index Funds and IPOs
3A poster on the forum brought up a great question on whether index funds would be forced to buy the upcoming Facebook IPO. The worry is that the index funds will load up on the IPO and take a loss later as the IPO price comes back down to Earth.
No, this isn’t likely to happen.
IPOs are, for the uninitiated, one of the worst investments to buy. The company and investment bankers hold all the cards. They set the date for the offering, set the price, set the shares to be issued, grease the skids with brokers by allowing some early access (which they’ll dump after the price goes up), etc. Never buy IPOs no matter how tempting the media hype says they are.
So why won’t the index funds go out and load up on a big IPO like Facebook? Well, they have entry requirements for the most part. The S&P index formulation requires IPOs not only be listed for a certain period of time (6-12 months), but also have a certain number of profitable quarters before they would be added. These guys weren’t born yesterday!
From Standard and Poor’s Eligibility Requirements starting on Pg. 5
Specifically, these two points will keep most of the IPO hype at bay:
Financial Viability. Usually measured as four consecutive quarters of positive as- reported earnings. As-reported earnings are Generally Accepted Accounting Principles (GAAP) net income excluding discontinued operations and extraordinary items. For REITs, financial viability is based on both as-reported earnings and Funds From Operations (FFO). FFO is a measure commonly used in REIT analysis.
Another measure of financial viability is a company’s balance sheet leverage, which should be operationally justifiable in the context of both its industry peers and its business model.
Treatment of IPOs. Initial public offerings should be seasoned for 6 to 12 months before being considered for addition to an index.
The index funds are not going to load up on Facebook when they go public (or they shouldn’t!). This is actually another good reason to own index funds and not actively managed funds that do not have these screening rules before buying stocks. Index funds still remain the single best way to own exposure to the stock market.
Now, if you really want to own a new IPO company for your variable portfolio (for money you can afford to lose), then let it just simmer for about six months and then buy into it. By then the price normally will have settled (usually lower) and you’ll have a better chance of making a profit.
EDIT: The Finance Buff asked about other indices like Russell 3000 and Wilshire 5000. These indices are more lax than S&P and will reformulate and bring in IPOs sooner. However they still have a lag time and it is not likely they will be going out and immediately bring in Facebook IPO based on their formulation criteria which I list below:
Russell Index Formulation and Methodology
Russell lists out the specifics on how IPOs are added beginning on Pg. 8.
Wilshire has their methodology here. They will do monthly, but it doesn’t look like the Facebook IPO is going to be snapped up immediately either:
In the past when someone asked what Small Cap value fund to use of Russell 2000 vs. S&P 600 for instance I would steer them towards the S&P versions because of their more sane screening process to weed out IPOs. I think S&P’s handling of IPOs is a smarter way to do it vs. their competitors.
Governments Like Inflation
51 week ago
Let’s talk about Treasury Inflation Protected Securities (TIPS) again. It’s no secret that I dislike them vs. gold in the Permanent Portfolio. But will they ever “default” as some say? No, they won’t. But this doesn’t mean they don’t have other serious problems.
I don’t believe the US will ever default on its debt because they control the money it is denominated in. They can simply print money to pay it all off. Not a good thing, but technically not a default. If you own $10,000 in TIPS and the Treasury hands you a $10,000 bill in the future they technically paid off the obligation. Of course the money may be worthless, but you did get paid back as stated in the agreement.
Now, what causes inflation? Inflation across an entire economy is caused by politics, not economics. It’s different than a shortage of a crop like corn that cause prices to spike in that one area. Inflation as a policy makes all prices go up together. This is a unilateral truth if you look at financial history.
Therefore, the idea of relying on the government causing the inflation to protect you from the inflation is a really bad idea. If the government really cared about protecting you from inflation they would implement monetary policies that balanced the demand for new money each year with the supply so inflation was 0% +-. But that’s not what they do. They target 3-4% inflation and often get it wrong and all sorts of things happen as a result.
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
What does this mean? Simple:
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
Why buy a product like TIPS from an entity that is actively working against your interests behind the scenes?
Even the much vaunted “independence” of the Fed is an illusion. Enormous pressure can be put on the Chair of the Fed to react in certain ways. I really enjoyed this paper for instance that discussed the Nixon tapes and the pressure put on Fed Chair Arthur Burns. Nixon wanted an easy money supply for political reasons at the risk of sending inflation even higher and it appears Burns complied. The taped quotes are interesting:
How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes
What’s the lesson from this (and likely other manipulations by later administrations)? Well it’s that true inflation protection is not going to be gained by trusting the people with their hands on the printing press.
TIPS may be wonderful if inflation is low and steady. But I have a very difficult time believing they are going to do any better than a simple short-term Treasury fund in terms of offering inflation protection under higher rates. In other words, they are very likely to just tread water or probably lose a little each year in the game of catch up if bad inflation comes to the US.
Don’t buy TIPS for the Permanent Portfolio. Gold is immune from a lot of political shenanigans that can affect the actual reporting of inflation and subsequent inflation adjusted payments. There’s nothing wrong with keeping 25% of your wealth in a form of money (gold bullion) that is not subject to the whims of those in power.
Harry Browne in 1970 Discussing the Coming Devaluation of the Dollar
0Harry Browne in September 1970 on the TV show “Firing Line” with William Buckley, Jr. He is discussing how the US government is going to break the gold standard and the kinds of repercussions it may have. The gentleman in the middle, Eliot Janeway, was proven completely wrong when Nixon did in fact end the gold standard on August 15, 1971 and touched off a decade of very bad inflation.
Hat tip to MediumTex on the forum for this video.
Timing Matters, but Emotions Matter More
0Market timing is something I’ve found many investors get drawn to eventually in their search for performance. My opinion is that market timing simply doesn’t work for a host of reasons. However it’s common to hear that if an investor just timed these various assets correctly they could have made X amount more. Yes, that’s true. But my take is simple: Timing matters but market timing doesn’t fix it.
Timing matters but market timing doesn’t fix it.
The issue is not that in hindsight that some mix of correctly timed buys would produce superior results. I don’t dispute that. But what I do dispute is that these things can be known ahead of time.
It is interesting because running this blog and forum I get people writing me all the time about timing the assets. Asset X is too much, Asset Y is a better buy, I’m going to wait on Asset Z. Etc.
I just tell them to buy all at once and be done with it. And that has proven to be the best advice over and over again. Not just because they will worry less about their money, but they will take their emotions out of the decision going forward.
It’s one thing to say an investor found some kind of timing mechanism that works on historic data. But it’s another thing entirely for them to actually follow it. What I’ve seen over and over again is that even if I thought their strategy were sound (which is practically never), they just don’t have the follow-through. More specifically, their timing system probably doesn’t work anyway and they’re using it as a way just to confirm their own biases and feelings for or against some asset class.
I had people writing me back in 2008 saying they didn’t want bonds because they were too expensive. By end of 2008 they went up +30%! So they got way more expensive.
Then in end of 2008 I told people to rebalance into stocks because they were decade low prices. But someone would write and point out all these technical analysis graphs showing, conclusively, that the Dow was going to 3,000 or whatever so they weren’t going to buy.
By end of 2009 stocks posted almost +30% gains.
Then in 2010 someone would write and not want to buy LT bonds. They said they got killed in 2009 with -20% losses and that 2010 would be just as bad because “interest rates have nowhere to go but up.”
Well they were wrong. Bonds were +9% for the year.
Then in 2011 someone would say that bonds, again, were going to lose money and they wanted to sit in ST cash because some guru had gone short on their maturity.
In 2011 LT bonds posted +30% gains.
But you know if someone had just bought all the assets and done nothing they’d have pulled in very good gains over these years with no hassle or stress. It’s easy money.
I understand the desire to time the markets. But aside from the technical aspect of knowing if the strategy will even work (it won’t), the bigger problem on top of it is that humans just aren’t good at controlling their emotions. They seek out data to confirm their biases. I have found repeatedly that this behavior not only makes them lose more money than someone that just bought in, but probably keeps them exposed to other market risks.
Here is a clip of Harry Browne discussing the same exact problem. De Ja Vu all over again:
Harry Browne on Timing Assets: Don’t do it!
Market timing doesn’t work. It doesn’t work for technical reasons and it doesn’t work for emotional reasons. Just buy the assets all at once and keep them rebalanced and you’ll be fine.
Reminder: Be sure to stay up to date on the upcoming Permanent Portfolio Book by signing up for the announcement list.
Trading Against Pros
0Doing some research recently I’ve found that almost 9 out of 10 of the trades on any given day on Wall Street are between professionals, not individuals. Think about that for a second. When you go to make a trade, 9 out of 10 times you are doing it against someone that does it for a living. And not just a living, but paid really big bucks to do it and has a tremendous amount of resources behind them. This includes mutual funds, pension funds, hedge funds, professional speculators, investment banks, etc.
But it gets even better. If 9 out of 10 trades are between professionals that means that most of the trades pros do are between each other. Now that’s interesting to consider. That means the average you see in the investing products on Wall Street represents the best that the pros on Wall Street can do in any single year.
Often I read about an investing strategy or trading method that claims to beat the broad market indices. That’s a pretty bold claim. I have to wonder if the sellers of these ideas are aware of the reality of trading on Wall Street. To think that you’re going to teach an individual investor to go up against a highly skilled pro and win. It’s kind of like telling an amateur golfer they are going to turn into Tiger Woods if they just buy the right golf club. It’s a fun thing to think about, but just not very realistic.
Even much vaunted hedge funds, the supposed masters of secret Wall Street strategies, often bomb. If they can’t do it, what chance does an individual have?
THERE’S yet more evidence that it makes sense to invest in simple, plain-vanilla index funds, whose low fees often lead to better net returns than hedge funds and actively managed mutual funds with more impressive performance numbers.
Basic stock market index funds generally aspire to nothing more than matching the returns of a market benchmark. So in a miserable year for stocks, index funds may not look very appealing. But it turns out that, after fees and taxes, it is the extremely rare actively managed fund or hedge fund that does better than a simple index fund.
That, at least, is the finding of a new study by Mark Kritzman, president and chief executive of Windham Capital Management of Boston. He presented his results in the Feb. 1 issue of Economics & Portfolio Strategy, a newsletter for institutional investors published by Peter L. Bernstein Inc.
The Index Fund Wins Again, Mark Hulbert February 21, 2009
http://www.nytimes.com/2009/02/22/your-money/stocks-and-bonds/22stra.html
I’ve been to financial firms on Wall St. in the past and had a chance to see some of their trading operations. These firms are trying everything possible to make a buck off each other. They are highly competitive and highly compensated if they manage to do it. Many use cutting edge hardware, algorithms and trading techniques trying to sniff out every last penny of advantage. There are actually magazines for the field (http://www.automatedtrader.net) discussing advanced applications in areas of High Frequency Trading and other esoteric topics.
These firms are looking for every possible edge to gain. And the harder they look, the more efficient the markets become. It is almost impossible to get an information edge, and therefore consistent excess profits, over anyone else at those levels. This is why, despite their best efforts, many funds cannot beat the market average once you subtract the costs from what they do.
You cannot compete against Wall Street with a home computer and technical analysis charts. The NSA would have a hard time competing against some of the computing power these firms have.
Sitting back and letting these people slice each other to pieces on trading is the best strategy. A Permanent Portfolio using a simple stock index fund let’s you do just that. You cannot compete against Wall Street with a home computer and technical analysis charts. The NSA would have a hard time competing against some of the computing power these firms have. This is why trading against the pros is a losing proposition on all fronts. Not only are you not likely to beat them, but they can’t even beat the simple market average themselves.
Conclusion?
Just own index funds where appropriate for your Permanent Portfolio. Don’t waste time and money trying to compete against those that aren’t even competitive against market averages.
Reminder: You can sign up for the announcement list for the upcoming Permanent Portfolio Book here.
