Where Have You Gone Benjamin Graham?

    Benjamin Graham was an American economist and professional investor.  However, he is probably more famously known as Warren Buffett’s mentor.  Though he passed away in 1976, Graham’s legend continues to grow.  Annually, you can find declarations from financial journalists, professional stock pickers and infamous bloggers, whom all declare to know what stocks Graham would be buying in the current market environment.  Great material to present to readers and followers, but I tend to avoid putting words in the mouths of deceased individuals.

    I owe all of my professional success to Graham.  It was his teachings, many years ago, that led to my very successful investment philosophy, which has been detailed in my popular book titled “Master the Markets with Mutual Funds: A Common Sense Guide to Investing Success”.  I assume performance is a measure of success, so my 9.12% 10 year average annual return, and my 144% gain during the “Lost Decade” (2000-2009) should qualify.  Keep in mind these returns were achieved while maintaining an average beta between .45 and .50 when measured against the S&P 500. 

   What my success has taught me is that you cannot try to learn from others while wearing blinders.  I have never seen discussed, as a topic, anywhere in the financial media the message that I took from the writings of Graham.  Yet they meant everything to me.  Everyone wants to talk about Graham’s process of security selection, and his interpretation of what constitutes of value stock.  That is exactly what people are looking for when they pick up his books, and therefore that is all they will walk away with when they are finished.  We are a society that wants a quick system to rely upon.  We do not want to hear about balance, re-balancing and diversification.  That is boring.  We want to get rich now, and maybe, just maybe, we can achieve instant wealth by reading about this Graham fellow. 

    I do not pick stocks and I am, at best, a clumsy security analyst.  I picked up the writings of Graham fifteen years ago looking for no quick answers or with prejudice.  The following are the words that I walked away with and that shaped my successful investment philosophy:

-        “the simplest choice would be to maintain a 50-50 proportion between high-grade bonds and leading common stocks, with adjustments to restore the equality”

-        “Nonetheless we are convinced that our 50-50 version of this approach makes good sense for the defensive investor.  It is extremely simple; it aims unquestionably in the right direction; it gives the follower the feeling that he is at least making some moves in response to market developments; most important of all, it will restrain him from being drawn more and more heavily into common stocks as the market rises to more and more dangerous heights.

-        “Furthermore, a truly conservative investor will be satisfied with the gains shown on half his portfolio in a rising market, while in a severe decline he may derive much solace from reflecting how much better off he is than many of his more venturesome friends.”

   

    The subtleness of Grahams suggestions are my strategy at its finest.  My successful 50-50 allocation strategy adheres to everything Graham suggested in the above writings.  He wasn’t just suggesting a 50-50 weighting for the defensive investor, but also maintaining that 50-50 weighting.  Well, what is that called?  It is called rebalancing. Even more exciting is the fact that we have access to asset classes that Graham never envisioned the average investor would be able to access.  That has led to an increase in diversification on the 50% equity side and an increase in disparity amongst equity holdings.  Do you think Graham’s star pupil has relied more on security selection or common sense over the years?  Well in the words of Mr. Buffett, “it isn’t a high IQ that produces superior investment performance, it’s rationality and curbing your emotions.”  That was the message I took from Graham.

    The point I am trying to make is that if you are constantly seeking the sensationalized approach, or the quick fix, then you will miss some of the greatest messages passed down by the world’s greatest teachers.  Graham is not here to tell us what stocks he would be buying today.  If he were, I believe he would be delivering a greater message, as he had in the past.  Sadly that message, would be once again lost on the average investor.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”

www.allocationforlife.com

Ignorance Is Bliss

    It seems mutual funds are once again in the cross-hairs of market timing professionals.  They always seem to be a popular target when the market fluctuates between extremes and I can’t really figure out why.  I assume those attacking mutual funds need the dramatics to help make their own content more interesting for viewers or readers.  Quite honestly, I don’t get the joke.
   
    Over the last 12 months, several financial news anchors have repeatedly found laughter in the fact that the average mutual fund does not outperform the market, and has seriously criticized mutual funds for being “long” only.  For those of you that don’t know, the term “long” simply means that you actually own an asset such as a stock.  Whereas, the term “short” refers to an investment that is not owned but rather a bet has been placed against that asset in belief or hope that it will go down.  The continuous barrage of insults upon the mutual fund industry bothers me because some of the people launching these insults were very successful mutual fund managers, and admittedly, they were “long” only managers.
   
    I realize that in today’s world the concept of actually owning an asset or being “long” for future growth is considered a stone-age concept.  However, I would suggest that professionals in the financial media consider their audience when making such comments.  Are they suggesting that the average investor should throw out the idea of owning a professionally managed mutual fund?  Or perhaps they are suggesting that you should borrow against your current assets to short a particular stock.  I believe the amount of traders parading in and out all day long on the financial networks forget that they are not just speaking to fellow traders.  Unfortunately, many viewers take their words as Gospel.  This leads to destructive investing, and I wish it would stop.
   
    Whenever I hear such bold suggestions or ridicule it always stimulates my mind.  Based on the so-called "expert" theory that a “long” only manager is handicapped because of their lack of vision or ability to “short” the market, I then began to wonder what managers would be considered the most handicapped of them all based on this theory?  My mind went directly to sector mutual funds.  You talk about being handcuffed!  Not only are the majority of these managers “long” only but they are even more restricted because they cannot step away from a specific sector;  no matter how out of favor that sector may be at the time.  For example, do you think a financials mutual fund manager felt very good about his or her performance last year? Probably not, but they could not step away.
   
    I decided to look at some numbers myself assuming that the severity of the handicap these managers endure will show up in the data.  I examined a portfolio of an equal investment made into mutual fund managers that covered each of the eleven major sectors within our economy.  My data began at the beginning of the “Lost Decade” and concluded at the markets close on February 10, 2012.  Here are the sector mutual funds I used and their results when compared to the S&P 500 Index:

Technology (Allianz RCM Technology Fund symbol: DRGTX)
Consumer Discretionary (Fidelity Select Consumer Discretionary symbol: FSCPX)
Financials (Davis Financial Fund symbol: RPFGX)
Telecommunications (T. Rowe Price Media & Telecom Fund symbol: PRMTX)
Industrials (Fidelity Select Industrials Fund symbol: FCYIX)
Utilities (Franklin Utilities Fund symbol: FKUTX)
Natural Resources (Fidelity Select Materials Fund symbol: FSDPX)
Real Estate (American Century Real Estate Fund symbol: REACX)
Healthcare (Prudential Jennison Health Sciences Fund symbol: PHLAX)
Consumer Staples (Rydex Consumer Products Fund symbol: RYCIX)
Energy (BlackRock Energy & Resources Fund symbol: SSGRX)

	SectorPortfolio	S&P 500
YTD	+7.33%	+6.98%
Trailing 12 Mos	+2.39%	+3.15%
3-Yr Avg. Annual Ret	+25.26%	+20.05%
5-Yr. Avg. Annual Ret	+4.28%	+.70%
10-Yr. Avg. Annual Ret	+10.89%	+3.87%
Since 1-1-2000	+10.98%	+1.11%/

    Does this portfolio look like it was hampered by having to be both “long” the market and stay within specific sectors?  If this is handicapped, then sign me up!  In the end, professional money management and diversification still hold a tremendous amount of value.  The problem is that diversification and asset allocation are quite boring to talk about.  When you are trying to sell ad space you better be delivering some type of dramatic commentary.  It seems people are more interested in who can shout the loudest and be heard instead of the quality of what is being said.

    I would like to now address the fact that the average mutual fund lags the overall market.  While I know this to be true I don’t quite see why it should matter.  Let me put this argument into context for you in a couple different ways that are more relatable.  The first example is a classroom that consists of five students who are all considered geniuses.  Now let’s assume that classroom is growing in size.  Instead of 5 students there are now 10, and then 15, and then 40.  The larger the class room size becomes the more average the performance of the class becomes when looked at as a whole.  When it comes time for the “Academic Bowl” which students do you think the professor is going to pick to be on the team?  The same is true of the mutual fund industry.  The fact that more and more mutual funds come on to the market, which makes overall performance average, does not mean that the high quality managers are difficult to find.

    “Fantasy Football” has become a national craze.  I have to tell you, I don’t understand how people come up with enough high quality players to draft and start in their fantasy league every week.  After all, when you look at the average performance per player in the NFL it is not very impressive.  How could the average performance be impressive when there are 32 teams in the league, suiting up 45 players per team for every game?  That is 1,440 players taking the sidelines every weekend.  Yet fantasy football league owners are still able to find around 7 high quality individuals to start each week.  They do not care about the average performance data per player for the entire league.  Just as I do not care about the average statistical performance of the mutual fund industry when I know the sample size is so large.

    In the end, your allocation and maintaining that allocation is more important to your long-term success than following some haphazardly recommended trading strategy that was probably not meant for your ears.  We cannot force the message to change but we can change the way we react to that message.  I wish I could hire some the retired fund managers turned news anchors to manage a portion of my assets in the same "long" manner in which they had so much past success.  I can't because they are retired.  My only hope is that they stop campainging as if they are still fund managers seeking assets and start taking into consideration who may be listening to their every word.

Thank you and good luck everyone.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”

The Great Debate: ETFs vs. Mutual Funds

    One of the most heated debates amongst individual investors is that which pits managed mutual funds vs. ETFs.  I speak from experience.  In the past I wrote a piece which dared to asked, “Which are better?”  The comments that followed resembled a heated exchange one may witness between Yankees and Red Sox fans.  For the record, “Let’s Go Yankees!”  Where was I?  Ah yes, the topic of managed  mutual funds vs. ETFs.  I feel I am qualified to discuss the topic without prejudice.  I own both ETFs and managed mutual funds.  I have also designed long-term successful portfolio strategies using both, and the return results can be found daily at www.allocationforlife.com.

    Many individual investors feel strongly for or against both mutual funds and ETFs.  However, the fact is there really is no correct answer as to which is a better investment choice.  In my experience I have found that a performance edge can be found for both based on current market conditions.  When looked at as a whole, ETFs tend to outperform the average mutual fund in periods of flat market movements or in times when the market seems to be moving straight up.  Managed mutual funds have a tendency of outperforming ETFs when the markets move aggressively lower and volatility is very high.  For example, let’s look at an allocation I use for both a managed mutual fund portfolio and an ETF portfolio.  The allocation is exactly the same for both models and the returns are as follows and as of February 6, 2012:

    Over the last 12 months my ETF model has outperformed my managed mutual fund model with a return of 6.47% vs. 5.26% (both of which are outperforming the 4.1% return of the S&P 500 over the last 12 months).  However, when we look at the 3 and 5 year average annual returns of the same portfolio, the managed mutual fund portfolio nicely outperforms its ETF counterpart.  The 3 year average annual return for my mutual fund portfolio is 16.53% vs. my ETF portfolio which is sporting an average annual return of 15.02%.  The same separation can be seen in the 5 year average annual returns for my two models.  The managed mutual fund model’s average annual return is 6.96% and my ETF model’s average annual return is 5.09%. 

    All we really need to examine is where the markets were three years ago, and recognize what happened between the third and fifth year of return data.  Three years ago the markets were on their way to the lows reached in March 2009.  In between that point and 2007 we had the extreme market plunge which began in the second half of 2008.  A managed mutual fund has the ability to separate itself from the rest of the market near the end of an extreme selloff.  The managers have cash on hand to invest in equities at extremely cheap valuations.  This makes a huge difference in performance because a mutual fund prices at the end of each day based upon the holdings performance within the mutual fund.  An ETF on the other hand prices throughout the day, not based on the underlying assets of the ETF, but based on the amount of shares of the ETF that are bought and sold throughout the trading day.  The ETFs pricing is purely based on supply and demand of the outstanding shares and a manager’s decisions do not affect the performance of the ETF one bit.

    The one thing that disturbs me, more than anything, about the mutual fund/ETF debate is the proclamation that ETFs are a better investment choice because they are cheaper to own.  For me, that is more of a question that comes down to an investor’s time horizon.  I love to use ETFs when I am trying to take advantage of cyclical moves within sectors.  They are very cheap to own and much more cost effective to trade.  Please let’s keep the term “trade” in mind as well as we reflect on Morningstar’s recent report that stated the average non-leveraged ETF is only held for 16 days.  16 days?  That alone should tell us that the debate is between two investment choices that are used differently by the majority of investors.  Still, let me move forward with examining if cheaper to own equals better performance.  The three examples I will be using will be the truest apples to apples comparison you will ever be presented with.  I compared three ETFs from their inception date to a managed mutual fund for the same period of time.  Here is the kicker.  The ETF and the managed mutual funds I chose are offerings from the same financial institution and not only that they share identical names.  Here are the results:

*** All data is from the ETFs inception date to the close of business on February 3, 2012

Vanguard Health Care ETF (VHT) Inception date: 1/26/04 to 2/3/12  +43.32%

Vanguard Health Care Fund (VGHCX) 1/26/04 to 2/3/12  +69.92%

iShares Cohen & Steers Realty Majors ETF (ICF) 1/29/01 to 2/3/12  +214.14%

Cohen & Steers Realty Shares Fund (CSRSX) 1/29/01 to 2/3/12  +237.35%

Columbia Large Cap Growth Equity ETF (RWG) 10/2/09 to 2/3/12  +31.25%

Columbia Large Cap Growth Fund A (LEGAX) 10/2/09 to 2/3/12  +36.04%

    In all three of the above examples the ETF offering from the fund company would have been a cheaper option to own than the managed mutual fund.  However, in all three examples the more expensive to own option would have made you more money.

    I have a horse in both races.  I know what I own and why I own it.  This debate will never be put to rest until investors can begin to clearly identify why they own an investment and what its objectives are within your overall strategy.  Blanket statements such as “Cheaper is better” do not cut it with people that know what they are talking about.   So the next time you find yourself ready to jump on board one side or the other, please realize that there is no correct answer and both sides, at times, can claim victory over the other.

Thank you.  Good luck everyone!

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success”

Capitalism: The Big Bank Theory

    How do you define capitalism?  In today’s world that question seems to be harder and harder to answer accurately.  While there has never been a consensus on the exact definition of capitalism, I have recently found that the privilege of living in a capitalistic society has been replaced by another definition of what that entails.  That new definition seems to include words such as greed and corruption.

    Capitalism only works in a free and open society where there is a balanced competitive scale.  The Civil War was fought because that scale was not balanced.  The northern states could not compete with the southern states in the marketplace.  The southern states had a clear and unfair competitive advantage because they employed slave labor.  Capitalism, as much as anything else, led to President Lincoln’s quest to end the disgusting institution of slavery, and restore the balance of economics.  Today, we could say the same unfair competitive advantages take place in other parts of the world where cheap labor and lack of worker’s rights are found in countries that are now our largest competitors.  This ladies and gentlemen is outsourcing and the main reason why the U.S. economy has been steadily declining.

    So here we are in 2012 in the midst of another presidential campaign.  A campaign where nightly news programs throw grenades in the form of insults with the far left accusing someone from the far right of being a greedy capitalist, and where someone from the far right accuses someone from the far left of being a socialist.  No one person, or political party, owns the definition of capitalism.  The benefits of capitalism are enjoyed by both political parties.  The fund raising dollars that all candidates depend upon come from a capitalistic society.  The most sizeable contribution dollars to both political parties come from the profits of corporate America. 

    So where does the anger and the confusion with capitalism stem from?  My belief is the banking/mortgage crisis which began in 2008.  2011 saw the rise of a powerful movement in the U.S. led by “Occupy Wall Street”.  While I agree with the movement’s anger, I also feel that they have misplaced their anger towards capitalism as a whole.  They seem to have trouble defining their anger and that comes from a lack of knowledge of the topic they are protesting.

    That brings us back to the question of “How do you define capitalism?”  I am a capitalist, and I believe in everything that a free and open market place has provided and will continue to provide.  I believe capitalism is a living system and that if you are willing to work hard and willing to assume some amount of risk, then it may pay off in a big way.  “May” being the keyword.  There are no guarantees in an openly competitive marketplace and that is the beauty of capitalism.  The free market determines the worth of your efforts.  My belief in capitalism is why I can clearly define my anger with the big banks, and tell you today that nothing they did to create the mortgage crisis resembled capitalism.

    The practices of the major banks during the real estate boom (which eventually led to the mortgage crisis and the plummet in the U.S. economy) spat in the face of capitalism.  As I previously stated, I believe the capitalist way of doing things is to reap the rewards or suffer the losses of the risk you are willing to assume.  The banks found a way to reap all of the rewards of the mortgages they were writing while pushing the risk they were taking on, by lending to riskier borrowers, on to others.  That is not capitalism, and the product that was created to pull this off was the Mortgage Backed Security (MBS).  The MBS allowed the banks to pool all of their high risk mortgages into bond offerings.  The MBS was then sold to the marketplace, and the capital gained from the offering was supposed to offset the risk of potential defaults on any of the riskier mortgages. 

    The MBS was an easy sale because ratings agencies like the Standard & Poor’s slapped a juicy AAA rating on the MBS offerings.  They never considered how risky the mortgages were that were packaged inside of the MBS.  The AAA rating altered capitalism because investors did not truly know the risk they were assuming when buying a MBS.  That is why when we are discussing the Standard & Poor’s decision on the credit rating of the United States that it does not mean much to me.  That agency time and time again has turned its back on doing the right thing.  Why would I care what they have to say about anything?  If they had not rated a pile of garbage ‘AAA’, then the Mortgage Backed Security would not have been easily sold and that would have forced the banks to stop writing high risk mortgages, or suffer the consequences themselves.

    Being born into a society that practices capitalism is a privilege.  So the next time you or someone you know wants to use the banking crisis as an indictment against capitalism, please remember that was not capitalism.  If you are looking to point a finger then start with the regulators and policy makers.  They approved the use of Mortgage Backed Securities while ignoring the obvious slap in the face to capitalism that defined the securities creation.

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success"  http://www.allocationforlife.com/

January 2012 Performance Data...A Good Start!

Today's post will be short and sweet.  I will be providing January return data for asset classes and sectors based upon the average mutual fund performance for each.  I will also be providing historical returns for my models, which can be found at http://www.allocationforlife.com/.

The overall markets were strong across the board.  The S&P 500 Index finished January with a gain of 4.48%, and the Wilshire Total Market Index was up 1.92%.  See my earlier post, http://bit.ly/ymMux5, for information regarding the "January Effect".  The strongest domestic asset classes were small caps, and based on last year's selloff it should be no surprise that foreign small and mid caps as well as emerging markets were very strong in the month of January.  It should be noted that data from the Investment Company Institute (ICI) showed that investors flocked out of all equity funds in the year 2011.  Gold had a very strong January, and unlike most of 2011 the miners followed.  Equity Precious metals led all asset classes in January.

Asset Class Performance Data For The Month Of January 2012

Domestic Large Cap Value       +4.26%

Domestic Mid Cap Value          +5.74%

Domestic Small Cap Value       +6.68%

Foreign Larg Cap Value             +5.57%

Foreign Small/Mid Cap Value   +7.94%

Domestic Large Cap Growth     +6.30%

Domestic Mid Cap Growth        +6.78%

Domestic Small Cap Growth     +6.89%

Foreign Large Cap Growth         +6.47%

Diversified Emerging Markets   +9.78%

Equity Precious Metals               +11.94%

Rea Estate                                     +6.38%

Commodities Broad-Basket        +3.88%

National Municipals Long           +3.11%

Intermediate-Term Bond             +1.44%

Industrial's (led by manufacturing) and Technology funds were the biggest sector winners in January.  Health Care, which has traditionally been the best performing January sector finished the month with a gain of 6.82%.  Holding true to form, Utilities were  the weakest sector in January finishing the month down on average 1.5%.  For information detailing historical February sector strength see my earlier post here http://bit.ly/yiUntd.

Sector Equity Performance Data For The Month Of January 2012

Technology                                 +8.57%

Consumer Discretionary           +5.86%

Financials                                    +7.40%

Telecommunications                 +1.82%

Industrials                                   +9.32%

Utilities                                       -1.50%

Natural Resources                      +7.76%

Real Estate                                  +6.38%

Health Care                                 +6.82%

Consumer Staples                      +.830%

Equity Energy                             +3.84%

Rea Estate                                   +6.38%

Equity Energy                             +3.84%

My Mutual Fund Models:

As of 01/31/2012	Model 1	Model 2	Model 3	S&P Index
YTD	+3.83%	+4.34%	+5.26%	+4.48%
12 Mo *	+4.17%	+2.96%	+1.33%	+2.51%
3 Yr **	+17.04%	+20.04%	+24.43%	+19.24%
5 Yr **	+6.81%	+5.84%	+4.11%	+.21%
10 Yr **	+9.09%	+9.91%	+10.94%	+3.60%
Since Inception ** 1/1/2000	+9.38%	+10.04%	+10.76%	+.91%
* Trailing 12 months ** Average Annual Return

My ETF Models:

As of 01/31/2012	Model 1	Model 2	S&P Index
YTD	+3.49%	+4.68%	+4.48%
12 Mo *	+4.92%	+3.49%	+2.51%
3 Yr **	+15.10%	+18.25%	+19.24%
5 Yr **	+4.94%	+3.95%	+.21%
10 Yr **	N/A	N/A	N/A
Since Inception ** 7/1/2006	+6.19%	+5.62%	+2.74%
* Trailing 12 months ** Average Annual Return

Thank you and good luck everyone!

Jon R. Orcutt, founder of Allocation For Life, is an asset allocation strategist and author of “Master the Markets with Mutual Funds: A Common Sense Guide To Investing Success