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Financial Happenings Blog
Thursday, January 12 2012
Jim Parker, of Dimensional Australia, in his latest Outside the Flags column points out some of the reasons why this firmdoes not include hedge funds in our investment approach.  It gets back to two key fundamentals:

- Understand into what you are investing
- Keep costs low

We don't belive hedge funds provide either of these outcomes.  Please find Jim's comments following.


January 5, 2012
Hedge of Darkness
Vice President
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It's true. Big money can be made from hedge funds. If you run one, that is.

That's the conclusion of a new book, which says people who invest in hedge funds would have been better off over the past nine years if they had stuck to a broadly diversified portfolio of vanilla stocks and bonds.

The book is called 'The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to be True'. It was written by Simon Lack, an asset manager who formerly chose hedge funds for major US bank JPMorgan.

Lack argues that the 18 per cent return on hedge funds in the nine years to November, 2011 was easily beaten by the total 29 per cent gain from the S&P-500 index. The gap was even starker for investment grade corporate bonds, which in the same period gained 77 per cent, as measured by the Dow Jones Corporate bond index.

Of course, the underperformance of hedge funds over this period is even greater once the customary 2 per cent management fee and 20 per cent performance fees charged by hedge fund managers are taken into account.

If individual hedge fund managers are generating the desired "alpha", or additional returns above the market, then the benefits of that skill tend to go to the managers themselves than to investors.

In fact, Lack estimates that from 1998 to 2010, the hedge fund industry captured at least 86 per cent of the returns it earned for its customers. This might explain why yachts cruising the Caribbean tend to be skippered by hedge fund managers, not investors.

For anyone who has followed the hype surrounding hedge funds for many years, this is not really a surprise. A good proportion of the investing public–egged on by the financial media–genuinely wants to believe that consistent market-beating returns are achievable without taking on additional risk and paying excessive fees.

From a marketing perspective, at least, the appeal is fairly evident. After all, the more exclusive you make a club, the more likely people will pay a premium for joining it.

While the hedge fund industry no doubt would contest the findings of Lack's book, one doesn't have to agree with his numbers to still harbour reasonable doubts about risking one's hard-earned savings by investing in hedge funds.

In a recent white paper1, Dimensional research associate Ronnie Shah explains that due to the lack of disclosure around returns, it is difficult to determine how much alpha, if any, hedge funds generate.

Industry groups that report hedge fund returns rely on voluntary disclosures by the funds themselves on the returns they generate. Shah notes this creates potential for biases in the data, such as the omission of poor returns or the dropping out of the returns of failed or discontinued funds.

This is in addition to other drawbacks of hedge funds, such as illiquidity, relative lack of oversight, the additional costs of leverage and derivatives and, of course, the substantial fees charged by the managers themselves.

Shah's paper concludes that the highly uncertain payoff from hedge funds, the high expense ratios and the lack of disclosure around them mean investors should exercise caution before investing in them.

Starting one up is another matter altogether.

1. Shah, Ronnie R., "Demystifying Hedge Funds: A Review" — Dimensional Fund Advisors

Posted by: AT 08:32 am   |  Permalink   |  Email
Wednesday, January 11 2012
More and more Australians are seeking out independent financial advice.  The key reason for doing so is to have some level of comfort that the advice that is being received is actually given to benefit you rather than your adviser (and his or her backer).

Unfortunately it seems that it consumers find it difficult to actually determine the independence of the adviser.  The latest Roy Morgan Research - Superannuation and Wealth Management in Australia - points out that many consumers even though they know a firm is owned by a major financial institution, such as the big four banks and AMP, believe that the advice they will receive is independent of any bias.

The report goes on to show that this is not the case with the following key findings:

  • 70% of products recommended by advisers working for an institutionally-owned licensee were provided by the parent company.
  • AMP planners were the most likely to recommend their own products, with 78.9% of their members directed into AMP managed products, followed by CBA/Colonial at 76.3% (in the 12 months to June 2011).
  • At the opposite end of the spectrum, only 41.5% of ANZ/OnePath advised customers were sold the group's products.
  • It was recognised in the report that these products may contain some funds managed externally.
For me, if you go to an adviser with links to a major financial institution, and 70% of the products recommended to you on average are products that are provided by the financial institution some alarm bells must be going off as to the independence of the advice.

The advice may be sound and the products recommended might just be the very best for you in your situation but some doubt must linger.  It is important to be going in to discussions with your eyes wide open and ask the tough questions.

So what big questions should you be asking?

1) Is the firm owned by another major institution?
2) Are there extra financial or promotion incentives for the adviser to recommend products from that financial institution?
3) Is the adviser limited to using certain products and if so why?
4) What is the underlying investment philosophy on which the product choices have been made?

A Clear Direction openly encourages consumers to find financial advice that is independent of what we refer to as "ownership bias".  If you want to find out more please get in contact.


Posted by: AT 09:01 am   |  Permalink   |  Email
Monday, January 09 2012
 A common perception over recent years is that diversification no longer serves an investor well.  Seemingly markets rise and fall in lock step as do the underlying companies.

2011 provided us with a reminder that markets and indeed companies are not as correlated as we might think.  The US was one of the strongest markets all be it just getting into positive territory when factoring in dividends - S&P500 2.1%.  Whereas the ASX200 had a relatively poor year falling 10.5% after including dividends.

(NB - If we take into account currency movements the S&P500 in Australian dollar terms did not do quite as well but still better than the ASX500.)

Within the top 25 Australian companies (by market capitalisation) there were quite varying returns over the past 12 months.  The Morningstar site this morning shows that Telstra has been the standout with a return of over 30%. Whilst at the other end Fortescue has been weak falling just under 30%.  Who would have thought this 12 months a go??

Weston Wellington from Dimensional Fund Advisors in the US, digs a ittle deeper into the data to show that there were also big differences between company returns over ethere.

The clear message is that the benefits to be gained from diversification are not dead.

Weston's article follows.  Well worth a read.

January 9, 2012
Year-End Review
Vice President
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Equity investors around the world had a disappointing year in 2011 as thirty-seven out of forty-five markets tracked by MSCI posted negative returns. The US did well on a relative basis and was the only major market to achieve a positive total return, although the margin of victory was slim. Total return for the S&P 500 Index was 2.11%, and the positive result was a function of reinvested dividends—the index itself finished the year slightly below where it started.

Throughout the year, investors seeking clues regarding the strength of business conditions or the prospects for stock prices were confronted with ample reason to rejoice or despair. Optimists could cite the strong recovery in corporate profits and dividends, the substantial levels of cash on corporate balance sheets, low interest rates and inflation, a booming domestic energy sector, continuing strength in auto sales, and record-high share prices for leading multinationals such as Apple, IBM, and McDonald's. Pessimists could point to persistently high unemployment, slumping home prices, tepid growth in retail sales, worrisome levels of government debt at home and abroad, and political gridlock in both Congress and various state legislatures.

Although the broad market indices showed little change for the year, there were opportunities to make a bundle—or lose one. Among the thirty constituents of the Dow Jones Industrial Average, thirteen had double-digit total returns, including McDonald's (34.0%), Pfizer (28.6%), and IBM (27.3%). But losing money was just as easy: The three worst performers in the Dow were Hewlett-Packard (–37.8%), Alcoa (–43.0%), and Bank of America (–58.0%). If nothing else, the substantial spread between these winners and losers discredits the argument we often hear that all stocks are now marching in lockstep and that diversification is ineffective.

Achieving even modest results in the US market required more discipline than many investors could muster, since investor sentiment fluctuated dramatically throughout the year and the temptation to enhance returns through judicious market timing often proved irresistible.

For fans of the "January Indicator," the year got off to a promising start as stock prices jumped higher on the first trading day, pushing the Dow Jones Industrial Average to a twenty-eight-month high. Bank of America shares jumped 6.4% that day, the top performer among Dow constituents. With copper prices setting new records and factory activity worldwide perking up, the biggest worry for some was the potential for rising prices and higher interest rates that might choke off the recovery. "Overheating is the biggest worry," one chief investment strategist observed. By April 30, the S&P 500 was up 8.4%, reaching a new high for the year.

Stocks wobbled through May and June but strengthened again in July. On July 19, the Dow Jones Industrial Average had its sharpest one-day increase of the year, jumping over 200 points, paced by strong performance in technology stocks. Just a few days later, however, stocks began a precipitous decline that took the S&P 500 down nearly 17% in just eleven trading sessions. The century-old Dow Theory—a sentimental favorite among market timers—flashed a "sell" signal on August 3, and on August 5, Standard & Poor's downgraded US government debt from AAA to AA+. As investors sought to assess the implications of sovereign debt problems in both the US and Europe, stock prices fluctuated dramatically, with the S&P 500 rising or falling over 4% on five out of six consecutive trading days in early August. Rattled by the sharp day-to-day price swings, many investors sought the relative safety of US Treasury obligations in spite of the rating downgrade, pushing the yield on ten-year Treasury notes to a record low. Stock prices hit bottom for the year on October 3 as some market participants apparently lost all confidence in equity investing. A Wall Street Journal article cited a number of individual investors as well as professional advisors who had recently sold all their stocks and did not expect to repurchase them anytime soon. "I feel like a deer in the headlights," said one.

As it turned out, the article appeared in print on the second day of a powerful rally that sent the Dow Industrial Average surging over 1,500 points during the next 19 trading days, putting it back into positive territory for the year.

What can we learn from a difficult year like 2011? As Dimensional founder David Booth is fond of saying, the most important thing about an investment philosophy is that you have one. Many investors (as well as some professional advisors) apparently decided to switch from a buy-and-hold philosophy to a market timing strategy in the midst of an unusually stressful period in the financial markets. We suspect few of those adopting the change would have been able to clearly articulate their investing beliefs and why they had shifted.

Legendary investor Benjamin Graham offered the following observation nearly forty years ago: "There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he himself is a part."

Good advice then, good advice now.

Mark Gongloff, "Investors' Forecast: Sunny With a Chance of Overheating," Wall Street Journal, January 3, 2011.

Jonathan Cheng and Sara Murray, "Stock Surge Rings in Year," Wall Street Journal, January 4, 2011.

Matt Phillips and E.S. Browning, "Tech Sends Stocks Soaring," Wall Street Journal, July 20, 2011.

Steven Russsolillo, "'Dow Theory' Confirms It's an Official Swoon," Wall Street Journal, August 4, 2011.

Damian Paletta, "U.S. Loses Triple-A Credit Rating," Wall Street Journal, August 6, 2011.

Tom Petruno, "Investors Stampede to Safety," Los Angeles Times, August 19, 2011.

Kelly Greene and Joe Light, "Tired of Ups and Downs, Investors Say 'Let Me Out'," Wall Street Journal, October 5, 2011.

Benjamin Graham, The Intelligent Investor (New York: HarperCollins 1949).

The S&P data are provided by Standard & Poor's Index Services Group.

MSCI data copyright MSCI 2011, all rights reserved.

Yahoo! Finance,, accessed January 3, 2012.

Posted by: AT 08:25 pm   |  Permalink   |  Email
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