Some Get It—Some Don’t

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MarketWatch reports that “Some stock-fund managers see cash as king:”

While many mutual fund managers boldly charge into stocks regardless of market conditions, others have kept their powder dry by holding more in cash.

For some of these managers, stashing cash has proved a valuable defense against the economic downturn. For others, boosting cash was a prudent decision at a time when stock valuations were too rich for their liking.

Whatever the reason, such moves in many cases mitigated the steep losses that other funds suffered in 2008. Of the 50 best-performing U.S. stock funds that reported cash holdings last year, the average portion in cash was 22.9%, while the median amount was 15.4%, according to data from investment researcher Morningstar Inc.

“[Cash] is part of my bag of tools to help manage people’s money prudently and safely,” said Ralph Shive, manager of Wasatch First Source Income Equity Fund, which has about 15% of assets in cash.

“Holding cash is part of my style, based on the business cycle,” said Shive, who typically holds between zero and 5% in cash. “I’m looking forward to a time when I can put it back in. I think about it every week, but I’m not there yet. We’ve got some serious structural problems.”

The manager of one of the country’s better-performing funds decided in August 2007 to build cash positions.

Since then, said Monem Salam, deputy portfolio manager at Saturna Capital, which manages the Amana funds, not much new investor money has been put into stocks. As a result, cash holdings of the Amana Income and Amana Growth funds have swelled from single digits to about 30%.

“We’re not selling to go into cash, but we’re seeing money coming in and staying in cash,” the fund manager said, adding that the few buys he’s made have been in stocks he considers defensive.

There are still some warning signs for the markets and the economy, Salam said, including whether financial institutions have finished writing down assets, how large the U.S. deficit will be and the scale of job losses.

“Some managers do it right,” said Ryan Leggio, a Morningstar fund analyst, of those who have high cash positions. Leggio said Morningstar is “agnostic” about the strategy. He added that there are some “great managers we’ve long admired” who use cash heavily in their portfolios.

One of those managers is Rikard Ekstrand, co-manager with Bob Rodriguez of FPA Capital, a value fund that has just under $1 billion in assets. While the fund typically has cash holdings in the single digits or low teens as a percentage of assets, starting 2004 it began building cash, which peaked at 43.6% of assets in November 2007.

Ekstrand said that, as a value fund, FPA Capital has strict criteria about the stocks it chooses. “We just weren’t finding values good enough to deploy our cash,” he said. Still, the fund lost 34.8% in 2008 largely due to concentrated investments in energy stocks.

Investors do raise questions about when the cash levels jump, Ekstrand said, but the fund’s managers respond by explaining they can’t find the right opportunities.

“We hate cash, but we hate stocks that don’t fit our criteria even more,” he said. He added that the fund has been spending its cash “in earnest” since October, buying mostly energy stocks. Cash holdings have dropped to 32% of assets from 38% on Sept. 30.

Yet the fact that some managers hold large amounts of cash and still collect a management fee for stock-picking may surprise some investors.

“When an investor initially invests in a fund, they probably do expect it to be fully invested,” said Morningstar’s Leggio.

But some stock-fund managers say holding cash is not their responsibility. They’re hired to be fully invested in stocks, and if investors want a place to park cash they can go to a bank.

“Our institutional managers don’t pay us to manage cash,” said Jason Farago, spokesman at Lord Abbett & Co. “Cash looks great in hindsight, but you then run the risk of missing the rally when the market recovers.”

“We believe that over a period of time, our [stock selection] formulas work,” added Frank Ingarra, co-manager at Hennessy Funds. “It’s all about time in the market rather than market timing.”

Leggio is critical of managers who hold cash simply because of a market downturn.

“If a manager’s scared of what’s going on, then do you really want to be in this fund?” he asked. He added that investors can leave a fund if they don’t like their fund managers being heavy in cash.

“You don’t have to stick around,” Leggio said. “There are plenty of great funds open that are fully invested.”


While some fund managers have obviously recognized the need to have a higher cash position this action, unfortunately, did not avoid major losses. It improved their performance relative to the overall market, which is better than being part of the “Bottom of the Barrel.”


And then there are those who don’t get it. Read those highlighted paragraphs again. Instead of giving credit to these few fund managers for having some foresight and not trying to go down with ship, Morningstar has chosen to chastise them for not being fully invested. It’s that type of clueless thinking that has caused the portfolios of millions of blind Morningstar buy-and-hold followers to register sharp losses in 2008, which will take many years to recover from.

My hope for 2009 is that Morningstar will focus on only providing data and stay away from useless commentary that will do nothing to help individuals learn from the past and become better investors in the future.

Sunday Musings: Words Of Wisdom

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I found this article written by Minyanville’s Peter almost exactly a year ago on January 8, 2008 titled “The Courage To Choose:”

Having been asked to provide my thoughts regarding 2008, I am going to stray a little bit from my usual Buzz & Banter messages and share what I see as the most important theme for 2008 – making choices.

I believe that in time, historians will define the last twenty years in America as the “Age of Aspiration” where, thanks to unprecedented levels of credit, Americans could become anything they wanted. Where, thanks to 0% down debt and a seemingly robust economy, we could own bigger homes, fancier cars, and more lavish vacations – where our bounty was limited only by the boldness of our wants.

Well, I, for one, believe that our Age of Aspiration is ending. And, with its conclusion, we must, for the first time in almost a generation, begin to reconcile our wants with our means. We must choose what to do without, rather than what more to do with.

But I would suggest that few of us are prepared for this challenge. Why? Because abundance relieves each of us from having to prioritize what is important. When anything is possible, everything is possible. Few of us have really had to choose.

As I look ahead to 2008, though, I believe that each of us, the communities we live in, and the organizations and companies we serve, are going to have to make choices. We are going to have to separate what is most important from least, and act accordingly. Where life was once limitless, it will now be constrained. And, like it or not, all of us will need to return to our vocabulary a simple phrase that I believe has been lost over the past 20 years: “I can’t afford that.”

So as we approach 2008, I wish the Minyanville community the wisdom to prioritize well, the courage to make the hard, and often painful, choices, and, most of all, the strength and conviction to follow through.

As we are entering 2009, these words no doubt are as valid as they were a year ago. The country continues to struggle from a sharply deteriorating economy, along with increasing job losses that are unfortunately bound to change the lives for many.

While we can’t change circumstances over which we have no control, we can enter 2009 with the knowledge that we have at least an investment plan in place that has survived the market disaster of 2008. Furthermore, it will provide us with the necessary guidance to deal with another treacherous year in the market.

If the first nine days are any indication of what’s in store, we may see much of a repeat of last year; that is sharp rallies followed by mind numbing drops interrupted by periods of sideways meandering.

In my view, only those investors with an exit strategy, who are big enough to admit when they’re wrong and don’t mind taking small losses in order to avoid large ones, will survive this bear market with their portfolios intact. I hope you will be one of them.

The Bottom Of The Barrel

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The past year has shown that even professional money managers of mutual funds with an impeccable past record are not immune to failure. MarketWatch reported that “In a bad year, these funds were the worst:”

Investors reeling from the 39% plunge of the Standard & Poor’s 500 Index this year should console themselves that it could have been worse: three of the worst mutual funds of 2008 have racked up losses of more than 60%.

Among non-leveraged U.S. stock funds with at least $100 million in assets, none did worse than Bill Miller’s Legg Mason Opportunity Trust , which as of Dec. 30 was down 66% this year.

The second worst performer, according to Morningstar Inc., was Winslow Green Growth, which is down 62% this year. The third-biggest loser was another fund from Legg Mason Inc. (LMGTX), which is down 61%.

The losses of these funds represent a lag of roughly 20 percentage points behind their broader category — domestic stock funds were down an average of 40% in 2008.

Opportunity Trust, which Greg Carlson, fund analyst at Morningstar, said was Miller’s go-anywhere fund, enjoyed market-beating returns from its inception in 1999 until its streak ended in 2006. But this year’s losses are so heavy that the fund’s three- and five-year annualized returns are now deeply in the red, down 27.9% and 14.5%, respectively.

The second Legg Mason fund, Growth Trust, a large-cap growth fund, is managed by Robert Hagstrom, a member of the Legg Mason Capital Management team.

Both funds suffered because of heavy bets in financial stocks that collapsed in value. Opportunity Trust held shares of Countrywide Financial, which was taken over by Bank of America Corp., and IndyMac Bancorp, which was seized by federal agencies after being declared insolvent. What also hurt Miller was his misreading of the broader economic environment.

“He continued to try to position the fund for a recovery,” said Carlson. “[As well as financials] he was also buying and adding to his holdings in home-building stocks and Internet companies including Amazon.com Inc., Expedia Inc. and Yahoo Inc.” This year, Amazon stock is down 44.9%, Expedia has fallen 73.3% and Yahoo is down 47.3%.

Growth Trust dived into companies including Freddie Mac and American International Group Inc. But despite its poor 2008 showing, Morningstar is bullish about the fund’s prospects.

“Legg Mason Growth will soar again,” said Bridget Hughes, senior fund analyst at Morningstar, in a Dec. 17 report. “We’re confident that the fund will perform well in an upswing. In fact, since mid-November, it has gained more than 7.5%, putting it near the category’s top (and ahead of its Legg Mason siblings).”

“Not that you can magically exclude bad years, but prior to the past year, the fund maintained a strong long-term record, even with periods of weakness mixed in,” said Hughes.

Legg Mason would not comment directly for this article, but in a statement Mark Fetting, president and chief executive officer, said, “Chairman and Chief Investment Officer [of Legg Mason Capital Management] Bill Miller has built a tenacious team of long-term investors. Thus far in their 26-year history, any period of underperformance has been more than offset by subsequent outperformance. We fully support their thoughtful action plans for improvement.”

I am not bringing this up to dwell on negatives, but to see if lessons can be learned. It appears that even professional fund managers don’t seem to be able to recognize a bear market if it hits them squarely in the face. To continue buying and holding stocks that were in obvious downtrends based on the very questionable assessment that they represented “value” surely backfired big time.

While I don’t have much sympathy for fund managers, I am concerned about the effects on the individual fund investors who, based on Legg Mason’s reputation, followed these funds blindly into abyss. How else can you describe a loss of over 60% when the market as a whole declined “only” some 40%?

Read the highlighted paragraphs again, in which Morningstar is desperately trying to put some lipstick on that pig. Sure, the funds may recover and do well in the future, but look at the damage they have done to not only an investor’s portfolio but his psyche.

If you were unfortunate enough to have your portfolio “diversified” in all 3 funds, you’re down a horrific 60% for the year. Look at the long-term consequences. Your $100k portfolio is now worth $40k. For you to get back to $100k, you need make 250% on the balance.

How likely is that and how long will that take? Given enough time, it’s likely; the question is whether you will still be alive to see it. Let’s say, given the current state of the economy, you could manage to compound your entire portfolio at a rate of 8% from hereon forward. That means it would take you 9 years to double your money and bring the balance to $80k. You’d then need another 3 years to get back to your original $100k.

So you’ve spent 12 years of your life making up losses assuming that you can consistently compound at 8%. If the market has another bad period, the time frame could easily increase to 15 years.

And all this could have been avoided with the proper use of a sell stop discipline. Makes buy-and-hope look kind of ridiculous, doesn’t it?

No Load Fund/ETF Tracker updated through 1/8/2009

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The bears got the upper hand this week as poor economic data killed all bullish ambitions.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains below its trend line (red) by -8.70% thereby confirming the current bear market trend.



The international index now remains -18.41% below its own trend line, keeping us on the sidelines.

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Whacking The Bulls

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The market took one on the chin yesterday with the result that the gains for January were just about wiped out.

The sell-off accelerated as many traders realized that it was impossible not to forecast a recession. While that is hard to believe, it seems that reality had not fully sunk in. The trouble started the night before as Alcoa announced major lay-offs of some 13,500 employees, which was followed by earnings warnings from Intel and Time Warner.

Crude oil plunged as falling demand caused oil inventories to rise. ADP’s payroll survey put down any remaining bullish hopes for the day as December’s whopping losses of 693,000 wrapped up one the worst years in history. This will not bode well for Friday’s jobs report, which also may turn out worse than expected.

It was a day of no positives as now India got rocked by its own version of the Enron debacle. As was to be expected, our Trend Tracking Indexes (TTIs) slipped and are confirming their position in bear market territory:

Domestic TTI: -8.44%
International TTI: -18.17%

I can still see more upside potential as part of a bear market rebound, but I still believe it’s better to stay away from any outright long or short positions.

Looking Ahead

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Lately, I have received quite a number of emails asking my view about 2009 and how one can establish some positions early to participate in upcoming market opportunities. Reader Ken put it this way:

Thanks Ulli for doing this great service, and writing all that you write with a lot of honesty, simplification and cutting through the noise-clutter.

There is a lot of talk about $ devaluation, and gold/silver appreciating. I know that you do not address specific ‘fads’ of the day/month/year, but this is one of those trends that will really even make the 3% return look bad if the $ gets devalued.

Are you planning to address this in your site or your blog in any meaningful way where we would/could get recommendations of an idea that we could protect our IRA / 401k / Taxable accounts?

Also, is this something that you could add ‘before’ the time comes to your portfolio so that we are already allocated?

In all of the above, I sound like I have read everything that you have published, but that is NOT the case. So, my apologies in advance if you have answered it, and I have not gotten to it. Please point me there and I will definitely read it.

First, let’s look at the dollar scenario. Sure, on the surface it would seem that all the bailout and stimulus packages of the past and future along with zero interest rates will eventually be devastating for the dollar. However, if you view this scenario globally, you’ll note that this current recession is a worldwide one and most other countries are forced to play the same games to prop up their ailing economies. So a potentially lower dollar may be offset by the actions of others. As the recession deepens and broadens, the ECB, BOE and China will eventually lower rates as well, which will be dollar positive.

Second, I am set against taking a wild guess by allocating a portfolio “before” it’s time. It’s simply not wise to try to outguess the market and establish positions now in the hope that one can get an early start.

It is far better if you wait and let the market come to you. In other words, wait for trends to develop before you jump aboard. You can easily follow that by watching the momentum numbers in my weekly StatSheet. Especially, be aware when prices cross their long-term trend lines, which you can follow in the column labeled %M/A, which shows you how far above or below its long-term tend line a fund/ETF is currently positioned.

2009 may very well be a continuation of the similar scenarios as we’ve witnessed in 2008. Sharp rallies will be followed by sharp collapses, and the jury is still out as to how long this bear may last. I think it’s far from being over, so capital preservation and avoiding overeager investment decisions are paramount to surviving with your portfolio intact.