Reuters Money
Zap zombie funds within your portfolio
Do you have zombie index funds within your portfolio?
Instead of eating up your brains, they devour your nest egg with high expenses and walking dead performance. They may be lurking within your 401(k)-type plan or individual retirement account.
I like index funds because they generally can track nearly any kind of asset class. As such, they are the white bread of investing and should cost about the same from fund to fund. The cheaper the better. Why pay Nieman-Marcus prices for the same thing you can get at Costco or Sam’s Club for less?
You can vanquish these funds without overtly violent acts, but first you have to identify them. Unfortunately, mandated fee disclosure is still pending, so you have to take the initiative.
So how do you identify a zombie fund? First you need a reliable benchmark for comparison purposes. The easiest way is to look at the index that the fund is supposed to be tracking. A good proxy for the U.S. bond market, for example, is the Barclays Capital Aggregate Bond Index. It’s a basket of listed bonds. If a fund tracks the index return within 0.20 percentage points or less, then that’s pretty good and not expensive.
A low-cost bond index fund would look like the Fidelity Spartan Intermediate Term Bond Index investor class fund, with a 0.20 percent expense ratio. You’d need at least $10,000 to get into this fund, though.
You want to pay a manager more to get less return on bonds? The ING US Bond Index portfolio charges a hefty 0.95 percent annually, meaning it will lag the index by nearly a full percentage point every year.
Tactical asset allocation might become your new normal
Market volatility is like a headache that hangs on. The cure may lie in shifting your mind from keenly focusing on risk instead of returns.
For many, this is an obvious no brainer, but it involves much more than simply shifting into cash, bonds or gold. What if you don’t want to exit stocks entirely? Then you may need what money managers call tactical asset allocation.
Instead of a long-only, hold-on-for-dear life approach of traditional investing, tactical planning involves shifting in and out of assets as market conditions dictate. In a turbulent market, there are several asset classes that can buffer stock downturns that can be found in several off-the-shelf mutual funds.
The linchpin of tactical investing is flexibility. It’s the opposite of the 60-percent stocks, 40-percent bonds fixed template. As a dynamic model, tactical portfolios are often open to moving into non-financial assets such as gold, real estate and commodities.
What I like best about tactical allocation is that it doesn’t go whole hog on any one asset class. Instead of loading up in the usual suspects in a bearish stock market — such as U.S. Treasuries or gold — it’s open to opportunities around the world. This can avoid big timing blunders and the prospect of being stuck in the wrong asset when markets turn.
It may be a while before the stock market turns bullish again when it’s being pulled in a number of negative directions. European debt woes, a sluggish U.S. economy and the prospect of a global recession are a menacing “lethal trifecta,” as Mohamed El-Erian, Chief Executive of PIMCO, noted recently.
“I worry that, absent a dramatic change in policies in America and Europe,” El-Erian wrote, “things will get worse before they get better. I fear that, given this possibility, it would then take years, if not decades, to repair the underlying damage done to economies, jobs and people’s lives around the globe.”
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Behind the Oceanstone Fund’s long run as a Lipper Leader
When an equity mutual fund receives Lipper’s highest rating of five for consistently superior, risk-adjusted three-year performance — along with other funds in the top 20 percent of its category—it may catch your attention.
When it gets that five rating consistently for 21 months — a record that Lipper’s research services head, Tom Roseen, calls “rare and worth a look” — you may be ready to plunk down some money.
But do your research first. The fund that currently holds this esteem is the Oceanstone Fund, a $15.5 million no-load, multi-cap value fund, which received its first five when it turned three (and became eligible) in November 2009 and its most recent five in July.
Its significance: Risk-adjusted performance reflects the volatility level its manager incurred to achieve it, and consistently superior risk-adjusted performance implies returns that are up more in up markets, and down less in down markets, than those of peer funds.
(Note the power of adjustments for risk, which can produce high ratings for consistency even when annual total returns fluctuated between negative 10 percent in 2008 and positive 264 percent in 2009.)
Not surprisingly, Lipper has also been rating Oceanstone a five for total returns and a four for capital preservation. High Lipper ratings, of course, would not alone constitute a recommendation — even if you ignore its one’s for low tax efficiency (because of taxable capital gains distributions resulting from portfolio turnover) and high (1.8 percent) annual expenses. Neither would Morningstar’s five stars for risk-adjusted performance.
Such ratings can, however, be a cue to check whether a fund is suitable.
“Sleep Well” funds: Where to invest for a good night’s rest
The following is a guest post by Lawrence Carrel, author of “ETFs for the Long Run” and “Dividend Stocks for Dummies.” The opinions expressed are his own.
Actively-managed mutual funds took a big hit in the stock market’s 2008 crash. The average equity fund plunged 39.5 percent compared with the 37 percent drop in the S&P 500 Index.
Many investors concluded, “if my active fund is going to fall more than a cheaper index fund, what am I actually paying for?”
Not much, it appears. But what if you could find a mutual fund that managed risk by significantly reducing losses in a down market, that could also capture profits when the market rallied? Now, that would be an expense worth paying.
After last week’s wild market roller coaster, a familiar refrain heard among investors was “where do I put my money now?” Wherever it goes, you can’t afford to stay awake all night worrying about your portfolio. That’s why we went searching for what we like to call “Sleep Well” funds. These are funds that can weather market volatility, give you peace of mind and let you get a good night’s rest.
For low risk, we looked at funds with high Lipper Leader ratings for capital preservation and consistent returns. Then we narrowed the list down to only those funds that beat the S&P 500’s total return over the past three years and over five sessions ending Thursday, Aug. 11. While a lot of funds don’t have a five-year record, it was mandatory that the fund lived through 2008 so we could see how well it fared during the market’s worst decline in the past decade. Finally, the fund couldn’t charge a load.
The Sierra Core Retirement Fund tops the list with a three-year annualized return of 11.93 percent vs. the S&P 500’s return of negative 1.03 percent, according to Lipper, which is a Thomson Reuters company. It tops this group by both falling the least in 2008 (2.95 percent) and rising the most in 2009 (30.44 percent vs. the S&P’s 26.46 percent surge), according to Morningstar.
Beaten down by market turmoil? The case for hedged mutual funds
The following is a guest post by Juliette Fairley. A frequent contributor to USA Today, Investor’s Business Daily, Bloomberg Wealth Manager and The New York Times, she is also the author of three personal finance and investing books. The opinions expressed are her own.
With the markets so volatile, financial advisers are screaming “diversify” from the rooftops. One small corner of the market that might attract attention in down times: hedged mutual funds.
Before the latest downturn, the hedged equity mutual fund category, which is comprised of only about 100 funds, was up 1.72 percent year-to-date. That’s less than the average equity mutual fund, of which there are about 10,000, which up 4.97 percent.
But in the tumult since the debt deal, the ratio turned to a 5.69 percent loss for hedged funds compared to a 7.83 percent loss for non-hedged funds, according to data from Lipper, a Thomson Reuters company, through Aug. 10, 2011.
That kind of split is why the hedged equity mutual fund remains a small specialty instrument in the toolbox of many financial advisers. Advisers like hedged mutual funds because they keep clients’ portfolios afloat in a down market, despite lower returns over the long-term.
“Hedged mutual funds act as a diversifier and can both reduce losses or make money. They are designed to return a small amount in any market. In balance, they are good by adding choice and selection to the client’s menu,” says John Longo, a registered investment adviser in Morristown, New Jersey.
Another advantage to hedged funds: lower fees. Traditional hedge funds, such as Paulson & Co. or Avenue Capital, charge two percent of the top 20 percent of any profit.
Duties for independent mutual fund directors piling up
The people whose job it is to protect shareholders’ investments in mutual funds nowadays — members of fund boards of directors — not only may be called on to do more things than any time since the Investment Company Act of 1940 created their positions; but they also have more power than ever before when dealing with the managements whom they oversee.
That is especially true for independent directors, who have been required to hold a majority of all funds’ board seats since 2002 and who are increasingly assigned additional responsibilities, most recently resulting from the mutual fund insider scandals revealed in 2003 and the 2007-2008 financial crisis.
When Congress drafted the 1940 act to supplement state business laws with federal mutual fund regulations, it faced a challenge. Unlike ordinary companies with internal managements, mutual funds were managed by the external investment adviser firms that sponsored them — and that tended to pick agreeable people to serve on the boards.
There were differences in the Senate and House on how to provide for two categories of directors: those who were “affiliated with” advisers and those who were not. They could easily be on opposite sides of an issue, as when advisers wanted higher fees, which could raise shareholders’ costs.
While the Senate bill required independents to have a majority, the House bill gave “affiliated persons” up to 60 percent of board seats. The House bill, limiting independents to 40 percent out of fear that an independent majority might reject an adviser’s recommendations, became law.
Both houses agreed on two major points: Funds using affiliated advisers required boards with independent majorities and only majorities of independent directors could approve contracts with advisers and principal underwriters.
It would be 30 years before Congress would correct a major flaw in the act with a word change, replacing “affiliated person” with “interested person,” which reclassified board members who had ties to advisers but were not counted as “affiliated” directors.
Investors warm up to emerging market bonds
In the late 1990s, the Asian currency crisis and Russia’s massive debt default crushed bonds issued in emerging markets in Asia, Europe and Latin America. Just three years ago, emerging market bonds tumbled as investors ran from anything that smelled of risk.
Now, as debt woes envelop the U.S. and Europe, economies in many developing countries continue to chug along at a healthy clip. And investors, drawn by strong returns and high yields on emerging market bond funds, have put a fledgling asset class on the map.
Last year those funds absorbed over $53 billion in new money according to the EPFR Report. This year investors have added another $15 billion, bringing total assets in the group to over $186 billion.
The driver behind this popularity has been performance. During the year ending July 11, emerging market bond funds had a total return of 12.4 percent, compared to 6.1 percent for taxable U.S. intermediate-term bond funds, according to Standard & Poor’s. Over the last three years they’ve averaged annualized returns of 9.3 percent, compared to seven percent for the latter group. The funds’ average 4.6 percent yield also beats the 2.76 percent yield on their U.S. counterparts by a considerable margin.
Behind those numbers is a story of how emerging market issuers have evolved from the bad boys of the bond world to up-and-coming role models with increasing financial strength. In emerging market countries, the average debt-to-GDP ratio — a measure of government debt as a percentage of gross domestic product — is less than half that of the U.S. and other developed countries. Nearly 60 percent of emerging market countries are rated investment-grade (BBB or higher), according to a report from Prudential, up from just 2 percent in 1993.
Companies in emerging markets often carry less debt than similarly-rated U.S. companies, and a number are top global players in their industries. Among them: Chili’s Codelco, the world’s largest copper producer; Russia’s Gazprom, a global leader in natural gas production; and Brazil’s Petrobras, a major offshore oil exploration company. All are rated investment grade, as are nearly 70 percent of emerging market corporate bonds.
How safe is your money-market fund?
Here’s a $12 trillion question: Are money-market mutual funds safe?
The industry insists that they are and banking regulators aren’t calling in the National Guard, although the U.S. Treasury Department is considering some emergency measures in case of a U.S. debt default.
Yet with the U.S. default risk hissing like a cobra, Congress and the White House at loggerheads and all the bad debt sloshing around Europe, is there a reason to be concerned?
Fear has reared its coiled head again. On Monday, stocks worldwide slumped on fears that Europe’s financial woes would spread to Italy.
If Congress doesn’t raise the federal debt ceiling, the prospects that interest rates will soar and there will be a run on money-market funds rise dramatically. Everything from company payrolls to Chinese stocks may get gobsmacked.
The government guarantees enacted in 2008 for money-market mutual funds are no longer in place. Money market accounts offered by banks with FDIC insurance are still covered.
Mutual funds are always subject to some credit risk, although it’s typically little since they only invest in relatively high quality short-term debt.
If the U.S. government is unwilling to honor its obligation to pay bondholders, how do we know that they will honor their obligation to insure bank accounts?
How to find your investing sweetspot
Dan Greenshields, CFA, is President of ING DIRECT Investing, a subsidiary of ING Bank, fsb. The opinions expressed here are his own.
In baseball, good hitters don’t chase pitches in the dirt. They wait to swing on a ball in their sweetspot — that small space over the plate at which they can maximize the power and accuracy of their bat. Good hitters are patient and make a point to play to their strengths.
The same is true for good investors. Chasing speculative, non-liquid or unusual investments can lead to heavy losses. But waiting and putting dollars into a financial sweetspot could bring maximum returns.
Here are three tips for how to find the sweetspot for your investments.
First, don’t drive your financial strategy with a tax strategy.
Some investments do indeed afford unique and substantial tax advantages. But if that’s the sole selling point for a particular investment, wait before handing over your money. The time to try to minimize taxes is only after you have fully reviewed your risk and liquidity needs.
However, when the time comes, the tax angle can be worked in a number of different ways.
How to avoid a China stock shock
Despite inflation worries, corporate accounting irregularities and drab stock market returns, China’s growth story continues to attract love from Wall Street.
More than 600 mutual funds and exchange-traded funds and nearly 300 companies listed on U.S. exchanges use “China” in their names, writes emerging markets investment specialist Carl Delfeld for Investment U, an investment advisory website. Many of the latter are China-based companies listed as American Depository Receipts.
But beneath the Chinamania is a laundry list of problems. While China’s GDP growth has galloped ahead of the rest of the world in recent years and is projected to continue doing so for the foreseeable future, most of its stock market indices have been considerably less buoyant. Over the last two years, a time when U.S. GDP growth trailed China’s by a wide margin, iShares FTSE/Xinua China 25 Index Fund rose 11 percent, compared to 43 percent for SPDR S&P 500.
Investors remain concerned on a number of fronts. At the top of the list: persistent inflation and the Chinese government’s efforts to control it. At the end of June, China’s consumer price index was poised to edge over six percent, something that hasn’t happened since 2008. That increases the likelihood of even tighter monetary restrictions for banks and higher interest rates in the months ahead as the government tries to rein in economic growth.
Opaque financial statements and accounting irregularities among public offerings conducted through a controversial technique called a “reverse merger” are the latest clouds hanging over a growing crop of small-company China stocks that have found their way to U.S. exchanges. Stocks of such companies, which merge with a publicly-traded shell company to gain back-door access to the U.S. markets, have been under investigation by the SEC for alleged manipulation by short sellers.
None of this, of course, means that the China growth story isn’t real. But for most people, tapping into the long-term expansion of the region’s burgeoning consumer mindset and infrastructure needs through investments that cast a net beyond its shock-prone stock markets is a better bet.
Companies that satisfy the growing Chinese appetite for consumer goods appeal to David Winters, manager of the Wintergreen Fund, whose portfolio has stakes in Swiss watch and timepiece makers Swatch Group and Richemont, the company behind the Cartier brand. “These companies derive about one-third of their sales from the greater China market and are capitalizing on the region’s increasing demand for luxury items,” he says. “Their presence in the region has also helped offset weaker sales in other parts of the word.” They also have strong balance sheets and high levels of management ownership.
