Archive for the Investment Managers Category

What does it cost to own a mutual fund? More than you’d like.

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How can investors know the real cost of a mutual fund?Executive Summary of article:

  • “… the average investor can’t begin to get an understanding of the costs due to the lack of information.”
  • Studies show that the average mutual fund costs between 2% and 3% per year.

According to Morningstar, Inc., most U.S. stock funds pay an average of 1.31% of assets to the portfolio manager each year in addition to other operating expenses. Other costs related to the buying and selling of securities are not reported in the expense ratio and those expenses can make a fund 2-3 times as expensive as advertised.

What exactly are the costs of owning a mutual fund?

There are four primary costs that affect a mutual fund’s price. These are:

  • Bid-ask spreads. These represent the gap between the lowest price at which a seller is willing to sell and the highest price the buyer is willing to pay. When the fund does a lot of trading on less-liquid holdings, such as small stocks, these costs can add up quickly.
  • Broker commissions. These are the commissions paid to the brokers who operate the fund. The SEC requires three years of these costs to be disclosed in a fund’s statement, but the SEC does not require them to be factored into the expense ratios.
  • Market-impact costs. These last two are often the largest component affecting trading costs. They occur when a large trade changes the price of a security before the trade is completed.
  • Opportunity costs. Opportunity costs occur when the impact of a trade inhibits a fund manager filling an order on their desired terms.

This results in either a less-favorable price or fewer shares transacted.
While it’s very important to look at the expense ratio before purchasing a mutual fund, it’s also important to understand that that number is not going to capture all the costs.

What do the experts say?

Richard Kopcke, an economist at he Center for Retirement Research at Boston College recently co-wrote a study about the fees and inherent trading costs of retirement funds, such as 401(k)s. Kopcke’s study reviewed the 100 largest U.S. stock funds held in retirement plans as of December 2007 and found that annual trading costs averaged from 0.11% in the quintile with the lowest costs up to 1.99% of assets in the quintile with the highest costs. The median was 0.66%. Kopcke’s conclusion was that the average investor can’t begin to get an understanding of these additional costs due to the lack of information.

Another study updated last year by Richard Evans, associate professor of finance at the University of Virginia’s Darden School, put the average trading costs of thousands of U.S. stock funds at 1.44% with an average of 0.14% in the lowest quintile and 2.96% at the highest. Evans’ conclusion was that high trading costs tend to have a negative impact on fund performance. On average $1 in trading costs decreased net assets by 46 cents in this study.

Stephen Horan, head of professional education content and private wealth at CFA Institute, a non profit association of investment professionals estimates that trading costs for stock funds total 2-3% of assets annually although conservative reported estimates put these costs closer to 1%. According to Horan, these transactional trading costs are very real and unfortunately, the expense ratio just does not capture all of the costs.

How can this be happening in these times?

One reason trading expenses are unreported is due to the complexity. That complexity leaves fund companies in disagreement about how to calculate the costs. Even fund experts have trouble coming up with estimates that are similar.

Of course, another reason is that fund firms aren’t all that anxious to disclose their costs either. The SEC tries to revisit this issue every few years, but it still hasn’t come to a conclusion or established a set of rules.

All of this leaves investors in the dark about the true cost of their mutual funds.

Where are we on the disclosure debate?

In 2003, the SEC indicated to Congress that trying to include all trading costs in the expense ratio would produce a number that was not comparable, and it would vary from fund to fund. There simply isn’t an agreed-upon methodology on how to quantify implicit transaction costs such as market-impact costs. Therefore, requiring fund managers to disclose total trading costs would result in investor confusion.

While nearly everyone agrees that investors are entitled to and should have that information, until the methodology is developed there will be a lot of larger companies who pay trading-cost consultants to estimate their trading costs, but midsize and small investment managers who can’t afford to pay accountants will continue to wait for the methodology to be developed.

Get Clues from the Turnover

Meanwhile, investors can get clues from a standard albeit imperfect measure of how much trading the fund is doing. This is called the turnover, and it shows at what rate stocks are being replaced in the fund. This is an imperfect measure because some stock funds that have a lot of new money coming in don’t have to sell to generate cash. In this case, their turnover rate would be zero even though the fund is likely buying a lot of stocks.

Last year, the SEC voted to require fund companies to disclose one year of turnover and move that information to the front of a prospectus. Turnover of more than 100% can indicate that the hidden trading costs may be on the high side. Of course, there can be a number of factors that impact turnover during a given period and turnover can vary over time. Still, it’s a clue as to the hidden trading costs that are undisclosed.

SEC Lawsuit Against Goldman Sachs

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Folded hands waitingOn Friday, April 16, 2010, it was widely reported in the media that the U.S. Securities and Exchange Commission (SEC) filed a civil lawsuit against Goldman Sachs Group, Inc. (“Goldman Sachs”) alleging investor fraud by failing to inform investors that a certain mortgage-based security product was designed with the help of someone who was also betting on that investment to fail.

The Investment Strategies team at Genworth Financial Wealth Management (GFWM), a major backroom resource we rely on for information, reached out to Goldman Sachs to better understand the scope of the inquiry and Goldman Sachs’ position on the issue. In order to provide our financial advisers with as much clarity around the situation as possible, we’d like to share our insights based on the conversations with Goldman Sachs:

  • First, the product in question in this particular lawsuit was created and sold by the Securities Division of Goldman Sachs. This group is a separate division of Goldman Sachs and functionally unrelated to the investment management division that is responsible for the asset allocation models, Goldman Sachs mutual funds, and sub-advisory services provided to some of our clients. Specifically, the lawsuit is brought against the Securities Division and not the Global Tactical Asset Allocation Team who is responsible for the Goldman Sachs’ portfolios we work with – regardless, we are continuing to conduct due diligence on our own and we’ll report back to you what we find.
  • Second, the transaction in question involved a privately structured product that was traded by sophisticated institutional investors. In contrast, the Goldman Sachs Asset Management products and Asset Allocation Strategies we use are delivered through highly regulated institutional channels. Plus, the Goldman Sachs sub-advisory services we employ are primarily in liquid fixed-income securities.

In addition, we’d like to include this statement from GFWM:

“The Investment Strategies team will be meeting with Goldman Sachs at their headquarters in the coming weeks as we accelerate our ongoing due diligence efforts in light of this news. Our due diligence process includes a deep examination of organizational and personnel structures both directly and indirectly related to the strategies provided through GFWM. While we expect and believe this issue to have little direct relevance to asset management services employed at Private Advisory Group, please be assured that we are working hard to stay abreast of the situation. In order to keep you updated, we will be making ongoing assessments of the possible impacts organizationally and of the possible effects on the asset allocation strategies and sub-advisory services being offered.”

Our Opinion

In our opinion, it may be premature to summarily ‘fire’ Goldman Sachs as an adviser until further details emerge and until the charges are either validated or dismissed. The Goldman Sachs’ track record has been solid for many years and in due course, it will become clear whether trusting this icon of Wall Street is justified or not.

Such problems as those currently being faced by Goldman Sachs’ Securities Division is one of the reasons we use a broad, robust platform of investment management teams. At Private Advisory Group, our investment teams give us a high degree of flexibility and coverage. While we cannot predict what may happen with any one firm, our unbiased approach to money management ensures we can monitor these types of events and best determine the appropriate course of action.

As always, we are not encouraged nor required to keep or use any particular advisory firm. Our primary incentive is to ensure that you are implementing the right strategies based on your goals and needs. If that means hiring, or firing, a firm then we can do so quickly, easily and without cost.

Should you have any additional questions or concerns, please do not hesitate to contact us.

Filed Under: Investment Managers

Winning by Not Losing–A Long Term Approach

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Golf Clubs #1

The Holy Grail in the investing world is a manager who is able to repeatedly time the markets—meaning they are fully invested when the market is moving up and fully in cash while the market is moving down. While many have claimed the ability, thus far no person or team of people have been able to successfully get in at the market lows and get out at the market highs on a repeated basis.

Nevertheless, after extensive research we found an investment team (Stadion) that has a proven track record of capturing most of the market upside while missing most of the market downside. Stadion is introduced in greater detail on the Current Commentary section of our website for those interested. (

Over the past 12 years, Stadion has more than a respectable track record. They have a 68% upside capture with only a 27% downside capture. Despite that high standard of performance, Stadion’s management team clearly acknowledges the following shortcomings, which have been borne out over the same 12 year period:

• They are not able, and do not try, to predict the future
• They are not able, and do not try, to pick market tops or bottoms
• They are not able, and do not try, to beat the market in the short term

Their ability to capture most of the good times, and miss most of the bad times rests in their entirely quantitative process where they use the weight of evidence to determine both market exposure and stop-loss parameters. Each data point in their proprietary matrix consists of multiple, complex indicators, which are run daily.

Essentially, the indicators they use measure the fundamental strength of the market, and based on that perceived strength they make calculated decisions about where and how much to invest. The primary weakness of this process is using quantitative approach to measure a qualitative entity. While medium to long term trends are based on fundamentals, short and especially hyper-short term trends are typically based on emotion or other qualitative parameters. Hence, short-term performance can be a disappointment to investor’s who harbor less than realistic expectations.

By design, Stadion’s approach is void of emotion or other subjective inputs, which means they are not subject to short-term, emotional reactions We see this as a positive and use them precisely for that reason. We want them to make decisions based on their calculated analysis of market fundamentals.

Such a focus on fundamentals can lead to some short-term anxiety as was the case recently on November 9, 2009 when the S&P 500 was up 2.22% and Stadion’s current allocation was 80% cash 20% commodities. At first analysis, it is easy to be frustrated that they missed the rally. However, as noted in the Wall Street Journal’s November 10, 2009 cover story, the November 9th rally was a “skeptics rally—fed by money managers who feel they must make risky bets in order to keep up with the market, but who don’t like what they see.” We hope you are beginning to better appreciate their time-tested wisdom.

While this ‘skeptics rally’ might continue long enough for market fundamentals to sustain it, we are not sure that is going to be the case. Stadion’s rules-driven approach dictates they avoid emotionally driven rallies and directs instead that they remain uninvested until the broader market measures indicate a more substantiated opportunity for growth. Conversely, during times when market fundamentals conclude additional market upside potential even while there may be an impulsive, unsubstantiated market pullback, Stadion would remain invested and might also miss on the short term.

So while we are confident that Stadion’s objective, disciplined research-driven approach will prove successful over a full market cycle, we acknowledge they will often, by design, lose to the market during the short term. This is especially true with repeated emotional, radical swings up or down like those we have recently experienced. For investors who are more interested in meeting or beating the market on a day-to-day basis, Stadion is not a viable option.

Just as a golfer with a bag full of clubs, each designed for a specific application under specific circumstances, we have manager teams that perform well in specific market conditions based on specific time horizons. Stadion is clearly a more defensive ’club’, and might be the right choice for an investor who would rather not “make risky bets” in order to keep up with the market, (even when they) don’t like what they see.

Filed Under: Stadion

Winning by Not Losing–Implementing their approach

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I thought you’d have interest in this reallocation alert issued by Stadion, one of our managers.

Soon after the start of June, we noticed a change in market dynamics. The succession of higher highs, higher lows and the climb of support through resistance changed its tune. Our indicators, which had been steadily increasing in a positive level, started a descent toward a negative reading. All of our equity exposures were removed following their respective stop loss thresholds being met during this pullback.

Our first reduction in equity exposure came on June 19, as XLB (Materials Select Sector SPDR) hit its stop loss level. A further reduction in equity exposure occurred a few days later on June 23 when our large cap market holdings of SPY (SPDR S&P 500) and DIA (Diamonds Trust) hit their respective stops loss levels. As the market continued its negative trend for the month of June, the remaining equity exposure was removed with the sale of XLP (Consumer Staples Select Sector SPDR) on June 26 as it hit its stop loss level.

Current market action calls for a position of safety which will either be rewarded by further declines, or turn into a “whipsaw.” While whipsaws are frustrating, we have no reservations about re-initiating equity exposure if dictated by our Model. Making money during the good times is nice, but only if you can protect it in the bad times.” Etc. Etc.

As of today they are 100% in cash waiting for the right time to get back in.

It is always great to see them actually do what they said they were going to do. And, given the fact the S&P is down 4.5% since Stadion decided to go back to cash, they are definitely winning by not losing!

Winning By Not Losing–A Disciplined Approach

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It’s true that no one can predict the stock market, but it is possible to know when conditions are favorable for making money—and
when they’re not.

Stadion’s three-part management approach allows us to do just that.

First, we use our quantitative investment model to assess the market’s risk level at any given time. Our model is built on several proprietary indicators that use internal market data and price trends to determine when we have an edge or when we need to be defensive. This weight-ofthe-evidence approach determines how much exposure Stadion investors will have to equities at any given time.

The second step in our tactical asset allocation process is making sure our portfolios are overweighted in the asset classes that are doing well and underweighted in asset classes that are out of favor.

The final step in the process is our objective, well-defined sell strategy. We do not hesitate to shift our portfolios to more defensive positions when market
internals weaken and intermediate price trends turn negative. Our safety measures may occasionally cause us to miss some market gains, but they are critical in helping us avoid devastating losses.

Debunking the Buy-and-Hold Myth

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Debunking the Buy-and-Hold Myth

Debunking the Buy-and-Hold Myth

Our active management approach radically differs from the typical “buy-and-hold” strategies often used by investors. Buy-and-hold means
staying invested in the market at all times, theoretically achieving the same results as the market.

Investors are sometimes misled by very long-term graphs that “prove” the value of this investment strategy. In reality, charts containing 80 years or more of data are simply irrelevant since the typical investor has only 15 to 20 years to build their retirement nest egg. History shows us there have been many periods of that length when a buy-and-hold approach would have been quite disappointing—or worse.

With buy-and-hold, average stock market investors spend two-thirds of their time working to break even—trying to recover from the cyclical downturns. At Stadion, we believe the best way to break even is to avoid big losses in the first place.

Winning by Not Losing

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winning-by-not-losingStadion’s investment method is called ”winning by not losing.” Their focus is on keeping returns as “real” as possible. To achieve this, they work hard to capture most of the market’s good times and miss most of its bad times. Losing less when the market goes down, means you have less to make up to get to a place where your returns are real, not just “relative”.

It is an approach that resonates with investors who want to earn a decent return over time, without worrying about suffering big losses in tough times.

Stadion’s winning-by-not-losing investment strategy has achieved solid long-term results without account damaging, confidence shattering drops along the way. During the Tech Bust, many investors watched in horror as their portfolios lost 25% to 50% of their value. Those investors subsequently needed returns of 33% to 100% just to break even. But because our investors didn’t suffer such severe losses, much of the return we captured in the market recovery was adding to our clients’ retirement wealth, not just recovering what had been lost.

More recently, the bear market that began in 2007 has stripped investors of the gains made during the post-Tech Bust upturn. In fact, by the end of 2008, buy-and-hold investors had experienced what was ultimately termed “The Lost Decade,” a 10-year period of little or no true gains.

Conversely, Stadion clients are protected from staggering losses during these types of bear markets. In fact, during that same lost decade (1999 – 2008), Stadion Managed Strategy investors saw their account values nearly double. We sometimes underperform the market during the up years (capture most of the good times) and then outperform it during the tough years (miss most of the bad times). The net result is what matters. Had you been invested
in Stadion over the past ten years, you would have a portfolio value significantly higher than if you had been in the S&P 500—and with much less volatility.

Their model not only creates a smoother ride, but it can also stabilize your account as you begin to take money out to live on postretirement. Market losses coupled with withdrawals can lead to account depletion that can never be recovered. But with Stadion, the first of these two dangers is drastically reduced.