September, 2010

By Editor

. . . from the archives at FundAlarm

David Snowball’s
New-Fund Page for September, 2010

Dear friends,

The Silly Season is upon us. It’s the time of year when Cleveland Brown fans believe in the magic of Jake Delhomme (those last 18 interceptions were just a fluke). And it’s when investors rush to sell low-priced assets (by some measures, the U.S. stock market’s p/e ratio is lower now than at the March ’09 market bottom) in order to stock up on over-priced ones (gold at $1240/ounce, up 30% in 12 months and 275% over five years). Again. Three examples of the latest silliness popped up in late August.

Trust us: We’re not like those other guys

A small advisory service, MarketRiders, is thrashing about mightily in an effort to get noticed. The firm offers a series of ETF portfolios. The portfolios range from 80% bonds to 80% stocks, with each portfolio offering some exposure to TIPs, emerging markets and so on. You take a sort of risk/return survey, they recommend one of their five packages, and then update you when it’s time to rebalance. $10/month. A reasonable-enough deal, though it’s not entirely clear why the average investor — having been assigned a portfolio and needing only to rebalance periodically — would stick around to pay for Month #2.

MarketRider’s key business development strategy seems to be hurling thunderbolts about, hoping to become . . . I don’t know, edgy? Their basic argument is that every other investment professional, from financial advisors to investment managers, operates with the singular goal of impoverishing you for their own benefit. They, alone, represent truth, virtue and beauty.

The last thing Wall Street wants you to do is start using a system that works. . . So here’s The System. Yale, Harvard, and wealthy families all over the world use it. Experts recommend it. MarketRiders has revealed and made it simple for you.

Actually, no. Harvard has 13% of its money in private equity, 16% in absolute return strategies, and 23% in real assets. Yale has 26% in private equity, 37% in real assets. God only knows what “wealthy families all over the world” buy.

One of their more recent rants compared the mutual fund industry to the tobacco industry, and likened Morningstar to the industry’s dissembling mouthpiece, The Tobacco Institute. A money blog hosted by the New York Times quoted their marketing e-mail at length, including the charge

For years, the mutual fund industry has waged a similar war against the passive index investment methods that we support. Like big tobacco, the mutual fund industry is large, profitable and immensely powerful. With large advertising budgets to influence “unbiased” mainstream media, they guide investors into bad investments. Morningstar has lined its pockets as a willing accomplice.

Given the presence of over 300 conventional index funds, including the world’s third-largest fund and 20 indexes with over $10 billion each, one might be tempted to sigh and move on. Add the 900 eagerly-marketed ETFs – including those from fund giants Vanguard and PIMCO – and the move away might become a determined trot.

In response to the Times blog, the estimable John Rekenthaler, Morningstar’s vice president of research, chimed in with a note that suggested MarketRiders substantially misrepresented the research both on Morningstar and on fund manager performance. Rather than respond to the substantive charge, MarketRiders’ president issued a typically pointless challenge to a five-year portfolio contest (following MarketRiders’ rules), with the loser donating a bunch of money to charity. JR has not yet responded, doubtless because he’s hiding under his desk, trembling, for having been exposed as a huckster. (Or not.)

It’s not clear that any of MarketRiders’ staff carries any particular qualifications in finance, though they might wear that as a badge of honor. They have only four employees:

Mitch Tuchman, CEO: venture capitalist. According to his various on-line biographies, for “27 years, Mitch has invested in and served as a troubleshooter for technology, software, and business services companies.” In 2000, he co-founded a venture capital fund specializing in b2b e-commerce projects. Later he advised APEX Capital “on the firm’s technology micro-cap and special situations portfolio.”

Steve Beck: “serial entrepreneur” with a B.A. in Speech.

Ryan Pfenninger: “accomplished technologist” with experience in computer games.

Sally Brandon: offers “diverse experience in product management, market analysis and client relations.”

They have no public performance record. Their website reports the back-tested results of hypothetical portfolios. Like all back-tests, it shows precisely what its creators designed it to show: that if, five years ago, you’d invested between 2.0 – 8.5% in emerging markets equities, you’d be better off than if you’d sunk all of your money into the S&P500. Which doesn’t tell us anything about the wisdom of that same allocation in the five years ahead (why 8.5%? Because that’s what we now know would have worked back then).

On whole, you’re almost certainly better off plunking your money in one of Vanguard’s Target Retirement funds (average expense ratio: 0.19% and falling).

Hindenburg (Omen) has appeared in the skies!

Be ready to use it as a convenient excuse to damage your portfolio. As one on-line investor put it in September of 2005, “The Hindenburg Omen thing weirded me right out of the market.” “Weirded boy” presumably missed the ensuing 4% drop, and likely the subsequent 12% rise.

This seems to be the Omen’s main utility.

The story of “the Omen” is pretty straightforward. A guy named James Miekka, who has no formal training in finance or statistics, generated a pattern in the mid 1990s that described market movements from the mid 1980s. At base, he found that a rising stock market characterized simultaneously by many new highs and many new lows was unstable. Within a quarter, such markets had a noticeable fall.

We are, according to some but not all technicians, in such a market now. For the past month, based on a Google News search, the Omen has appeared in about 10 news stories each day. The number is slightly higher if you include people incapable of spelling “Hindenburg” but more than willing to agonize about it.

The Hindenburg has passed overhead on its way to its fateful Lakehurst, NJ, mooring 27 times since 1986 (per CXO Advisory, 23 August). Its more recent appearances include:

April 14, 2004

October 5 2005

May 22 2006

October 27 2007

June 6 and 17 2008

August 16 2009

Faithful followers have managed to avoid five of the past two market declines. It’s about 25% accurate, unless you lower the threshold of accuracy: in 95% of the quarters following a Hindenburg warning, the market records at least one drop of 2% or more. (2%? The market moves by more than that on rumors that Bernanke hasn’t had enough fiber in his diet.)

So why take it seriously?

First, it’s more dignified than saying “I’m not only living in the state of Panic, I’ve pretty much relocated to the state capitol.” The condition is true for most investors since the “fear versus greed” pendulum has swung far to the left. But it’s undignified to admit that you invest based on panic attacks, so having The Hindenburg Omen on your side dignifies your actions. Fair enough.

And too, Glenn Beck uses it as proof that the Obama administration’s economic policies aren’t working.

Second, it has a cool back story (mostly untrue). The story begins with James Miekka, almost universally designated a “mathematician” though occasionally “brilliant technical analyst,” “blind mathematician” or “blind oracle.” Which sounds ever so much cooler than the truth: “legally blind former high school algebra and science teacher with a secondary education.” The exact evolution of the Omen is fuzzy. It appeared that Mr. Miekka sat and fiddled with data until he got a model that described what had happened even if it didn’t exactly predict what would happen. Then he adjusted the model to align with each new incident, while leaving enough vagueness (it only applies in “a rising market” – the definitions of which are as varied as the technicians seeking to use it) that it becomes non-falsifiable.

Third, it has a cool name. The Hindenburg Omen. You know: “Ohhhhh! It’s–it’s–it’s the flames, . . . It’s smoke, and it’s flames now . . . This is the worst thing I’ve ever witnessed.” Technicians love spooky names. They’re very marketable. Actual names of technical indicators include: The Death Cross. The Black Cross. The Abandoned Baby. The Titanic Omen. The Lusitania Omen.

Miekka actually wanted “The Titanic Omen,” but it was already taken so a friend rummaged up the poor old Hindenburg. As a public service, FundAlarm would like to offer up some other possibilities for technicians looking for The Next Black Thing. How about, The Spanish Flu Pandemic of 1918 Omen (it occurs when a third-tier nation manages to sicken everyone else)? Or, The Half Billion Contaminated Egg Recall of 2010 Omen (which strikes investors who made an ill-timed, imprudent commitment to commodities)? Maybe, the Centralia Fire Signal (named for the half-century old underground fire which forced the abandonment of Centralia, PA, the signal sounds when small investors have discovered that it’s a bit too hot in the kitchen for them).

“Danger, Will Robinson, Danger! I detect the presence of bad academic research”

Academic research really ought to come with a bright red and silver warning label. Or perhaps Mr. Yuk’s lime-green countenance. With the following warning: “Hey, you! Just so you know, we need to publish something about every four months or we’ll lose our jobs. And so, here’s our latest gem-on-a-deadline. We know almost no one will read it, which allows us to write some damned silly stuff without consequence. Love, Your Authors.”

The latest example is an exposé of the fund industry, entitled “When Marketing is More Important than Performance.” It’s one of those studies that contains sentences like:

R − R =α +β *MKTRF +β * SMB +β *HML +β *UMD +ε ,t=T-36,T-1

The study by two scholars at France’s famed INSEAD school, finds “first direct evidence of trade off between performance and marketing.” More particularly, the authors make the inflammatory claim to have proof that fund managers intentionally buy stinky stocks just because they’re trendy:

. . . fund managers deliberately prefer marketing over performance.

Funds deliberately sacrifice performance in order to have a portfolio composition that attracts investors.

Their work was promptly featured in a posting on the AllAboutAlpha blog and was highlighted (“A New Study Casts Fundsters in an Unflattering Light”) on the Mutual Fund Wire news service.

All of which would be more compelling if the study were worth . . . oh, say, a pitcher of warm spit (the substantially cleaned-up version of John Nance Garner’s description of the vice presidency).

The study relies a series of surrogate measures. Those are sort of fallback options that scholars use when they can’t get real data; for example, if I were interested in the weight of a bunch of guys but couldn’t find a way to weigh them, I might use their shirt sizes as a surrogate (or stand in) for their weight. I’d assume the bigger shirt sizes correlated with greater weight. Using one surrogate measure introduces a bit of error into a study. Relying on six of them creates a major problem. One key element of the study is the judgment of whether a particular fund manager had access to super-duper stock information, but failed to use it.

They obviously can’t know what managers did or did not know, and so they’re forced to create two surrogate measures: fund family size and the relationship of portfolio rebalancing to changes in analyst recommendation. They assume that if a fund is part of a large fund complex, the manager automatically had access to more non-public information than if the fund is part of a boutique.

The folks are Matthews Asia Funds beg to differ.

Scott Barbee of sub-microcap Aegis Value (AVALX) rolls his eyes

John Montgomery, whose Bridgeway funds have no use for any such information, goes back to fine-tuning his models.

The managers tend go on to correlate the often six-month old fund portfolio data with analyst recommendations which change monthly, in order to generate a largely irrelevant correlation.

And, even with a meaningful correlation, it is not logically possible to reach the author’s conclusions – which attribute specific personal motivations to the managers – based on statistical patterns. By way of analogy, you couldn’t confidently conclude anything about my reasons for speeding from the simple observation that I was speeding.

At most, the authors long, tortured analysis supports the general conclusion that contrarian investing (buying stocks out of favor with the public) produced better results than momentum investing (buying stocks in favor with the public), though making trendy, flavor-of-the-month investments does attract more investor interest.

To which we say: duh!

Briefly noted:

Harbor has abandoned plans to launch Harbor Special Opportunities fund. The fund has been in a holding pattern since March 2009. Harbor filed a prospectus that month, then filed “post effective amendments” every month since in order to keep the fund on hold. On August 26 they finally gave up the ghost. Harbor is also liquidating their distinctly mediocre Harbor Short Duration Fund [HRSDX) in the next month.

Speaking of ghosts, four more Claymore ETFs have left this world of woe behind. Claymore/Zacks Country Rotation,Claymore/Beacon Global Exchanges, Brokers & Asset Managers Index ETF, Claymore/Zacks Dividend Rotation, andClaymore/Robb Report Global Luxury Index ETF are now all defunct. According to the firm’s press release, these are dumb ideas that failed in the marketplace. No, they’re celebrating “product lineup changes.”

The Robb Report Global Luxury ETF? For those who don’t subscribe, The Robb Report is a magazine designed to let rich people (average household income for subscribers: $1.2 million) immerse themselves in pictures of all the things they could buy if they felt like it. If you want the scoop on a $418,000 Rolls Royce Phantom Coupé, these are the guys to turn to. The ETF gave you the chance to invest in the companies whose products were most favored by the nouveau riche. Despite solid returns, the rich apparently decided to buy the car rather than the ETF.

Does it strike you that, for “the investment innovation of the millennium,” ETFs are plagued with rather more idiocy than most other investment options?

Two actively managed ETFs, Grail RP Financials and Grail RP Technology are also being . . . hmm, “moved out of the lineup.”About two dozen other ETFs have liquidated so far in 2010, with another 350 with small-enough asset bases that they may join the crowd.

Folks not able to make it to Iowa this fall might find that the next-best thing is to pick up shares of a new ETF: Teucrium Corn CORN. Long-time commodity trader Sal Gilbertie was “shocked” (“shocked, do you hear?”) to learn that no one offered pure-play corn exposure so he stepped in to fill the void. Soon to follow are Teucrium Sugar, Trecrium Soybean and Teucrium Wheat Fund.

Shades of Victor Kiam! The employees of Montag & Caldwell liked their funds so much, they bought the company. Montag was a very fine, free-standing investment advisor in the 1990s which was bought by ABN AMRO, which merged with Fortis, which was lately bought by BNP Paribas. Crying “no mas!” the Montag folks have reasserted control of their firm.

In addition to merged FBR Pegasus Small Cap Growth into the FBR Small Cap, FBR has decided to strip the “Pegasus” name from the series of very successful funds that David Ellison runs: FBR Pegasus becomes FBR Large Cap with a new “principal investment strategy” of investing in large cap stocks. FBR Pegasus Mid-Cap and FBR Pegasus Small Cap lose the “Pegasus” but keep their strategies.

In closing . . .

As summer ends, I mourn all the great places that I haven’t had a chance to visit. My morose mood was greatly lightened by Catherine Price’s new book, 101 Places Not to See Before You Die (Harper, 2010). I’ve always been annoyed by the presumptuous twits who announce that my life will be incomplete unless I follow their to-do list. The “before you die” genre includes 2001 Things to Do, 1000 Places to See, Five Secrets You Must Discover, 1001 Natural Wonders You Must See, 1001 Foods You Must Taste and unnumbered Unforgettable Things You Must Do. I was feeling awfully pressured by the whole thing but Ms. Price came along and freed me of a hundred potential obligations. She X’s out the Beijing Museum of Tap Water, the Blarney Stone and the entire State of Nevada. I’m feeling lighter already. If you’d like to share in my ebullience and help support FundAlarm, use FundAlarm’s special link to to pick up a copy. (By the way, there’s a similarly-titled book, Adam Russ’s 101 Places Not to Visit: Your Essential Guide to the World’s Most Miserable, Ugly, Boring and Inbred Destinations while is a parody of the “before you die” genre while Price actually did visit, and abhor, all of the places in her book.)

I’ll see you next when the trees start to don their autumnal colors!