The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged stocks
Standard & Poor’s SPIVA Report – Passive beats active…as usual.
2 months ago
Just going over some data on actively managed vs. passively managed funds and wanted to post the Standard & Poor’s Indices Versus Active (SPIVA) report link:
S&P is the creator of the S&P 500 index plus a variety of other domestic and international stock and bond indices. They put out their report card each year to see how industry wide performance matches up to simple index tracking funds. As you may know if you follow the passive investing style of the Permanent Portfolio, actively managed funds do poorly. Here are some highlights:
Over the past three years, which can be characterized by volatile market conditions, 63.96% of actively managed large-cap funds were outperformed by the S&P 500, 75.07% of mid-cap funds were outperformed by the S&P MidCap 400 and 63.08% of the small-cap funds were outperformed by the S&P SmallCap 600. – SPIVA Report 2011
Over five years ending June 2008, S&P 500 outperformed 68.6% of actively managed large cap funds, S&P MidCap 400 outperformed 75.9% of mid cap funds and S&P SmallCap 600 outperformed 77.8% of small cap funds. – SPIVA Report 2008
Pretty much as expected. Actively managed funds will underperform once management costs are subtracted. With average annual expense ratios on funds around 1.3%, it means that the average fund is likely to underperform the index average by at least 1.3% a year. Index funds have the advantage because their management fees are so low. An index fund by comparison may charge only 0.20% (or even less than 0.10%) a year leaving the rest of the market returns for the investor and not the managers.
It doesn’t look good for international funds, either:
Among global equity funds, five-year results show S&P Global 1200 outperforming 70.1% of global equity funds, S&P 700 outperforming 86.5% of international equity funds, and S&P IFCI Composite outperforming 73.9% of emerging market funds. – 2008 SPIVA Report
Also Wall Street continues the tradition of merging or liquidating poor performing funds at a very high rate. Over the years the disappearance of badly performing funds from the books helps to boost the remaining funds’ performance figures:
Funds disappear at a meaningful rate. Over five years, 26.8% of U.S. equity funds, 22.5% of global equity funds and 24.7% of fixed income funds have been merged or liquidated. – 2008 SPIVA Report
The SPIVA reports only go back five years at a time, but going back further means the results just get worse for actively managed funds and better for the low cost index funds. The above is why the Permanent Portfolio only uses index funds for the stock allocation and does not try to beat the market with timing strategies, etc. Over the long run, just trying to capture the market returns is the best way to beat virtually all active money managers.
Risk and the Future
2 months ago
Let’s talk about risk and the future.
Sometimes I get a question about event X or event Y or event Z. These can sometimes be extreme events that someone is worried over. They often want to know how the Permanent Portfolio will deal with one or all of them.
My answer is that nobody knows what every possible hypothetical event will lead to in terms of unintended consequences. Even a portfolio you think will do best under event X may in fact do quite poorly if you guess incorrectly how the markets will react. Many investors in fact have been burned in just this very way. In other words, you can be right about a bad event happening, but totally wrong on how to invest to protect yourself from it. I never assume I know how the markets will react to a piece of news myself. I’ve been surprised often enough to know it just isn’t very profitable.
However what I most appreciate about the Permanent Portfolio is the fact that it is a way to diversify against a wide variety of serious or not-so-serious economic risks without having to guess about anything. As an entrepreneur, I like having options at all times to deal with the uncertain and the Permanent Portfolio does that. I don’t however spend a lot of time considering every possible scenario that could play out because it likely won’t happen that way. At least that’s what I’ve found in the business world and life in general. I think the best strategy continues to be one in which it makes no assumptions about any particular future, but at the same time gives an investor access to assets to accommodate even extreme situations if they show up.
For instance, let’s say the stock market dives by 50% tomorrow. If your portfolio was very heavy into stocks this would be a disaster. But if your portfolio is more Permanent Portfolio style the damage is limited. The 25% division of the four major assets of stocks, bonds, cash and gold limit your downside overall. Further, you would also have access to options to deal with the disaster (such as rebalancing into stocks with your cash, bonds and gold which is very likely the best option).
The Permanent Portfolio gives you options to deal with various contingencies if they should happen.
Or let’s say that happy days are here again and gold drops by 50%. That will be bad news for gold, but probably pretty good news for stocks. Take those profits and buy the yellow metal that everyone now hates because eventually they’ll want it again. Portfolio damage is limited because the downside of the gold can be absorbed by the upside in the stocks.
On the opposite end, if Treasury bonds tank and yields rise to 10% tomorrow the gold allocation will be there to deal with the very high inflation. This will allow a rebalancing into what is likely going to be lucrative high yields on your bonds once inflation comes back down. The gold gives you that option that a concentrated portfolio alone might not.
Finally, if you find out in 10 years that the US has gone to pot and a very dangerous government is rising to power you can make a decision to keep the gold separate and not rebalance. Instead you can hold the asset for the perceived emergency. There is nothing set in stone that says you must rebalance out of gold if you thought there was a extremely serious danger and you thought you’d need it. The future is unpredictable and because you hold the gold at least you have an option that other investors may not.
Each situation needs to be addressed when it comes about. However, the Permanent Portfolio gives you options to deal with various contingencies if they should happen.
I’ve never found that dwelling on doomsday scenarios to be very useful because the future rarely ever works out the way we think. Usually it is new and surprising outcomes that nobody expected that are the problem. Instead when you think about risk and the future, think of how useful a flexible portfolio with a wide range of assets is to deal with it. When I look at the problem that way, I’m glad I run the Permanent Portfolio and don’t concentrate my bets. I like having options and the Permanent Portfolio gives them to me.
Index Funds and IPOs
3 months ago
by Craig Rowland
in Investing
A 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.
