The myth of asset allocation

Don’t tell mikebutler or bankrep. They love asset allocation.

Higher risk equals high return.  How that is utilized is up to the
individual.  Asset Allocation is a sales gimmick - nothing
more.  It’s a way for people to spend more time selling and less
time managing portfolios.  It’s not a great way for the client to
get rich.



Look at EIAs and their popularity - same sort of high fee, low benefit product.

[quote=dude]

Let me know what y'all think of the following link.

http://www.financeware.com/Ruminations/AllocationMyth.PDF

I have some more links along these lines if you're interested.

[/quote]

This kind of stuff is always interesting to debate, but this guy lost all credibility with me in his first footnote where he tried to make the case that dollar weighted as opposed to time weighed returns somehow undermined Asset Allocation. Note that he’s not an advisor, he simply sells software to those of us who are.<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Financeware.com, in <?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Richmond, Va., wants to be an online partner to planners, according to its president and chief executive officer, David B. Loeper. He assures planners that he knows how to communicate with clients. "Most advisory services are backward-looking," he says. "They track performance records that show you what did happen but not what will happen." And Financeware.com, says Loeper, will solve this problem. Proprietary analytics take a client's financial data and calculate the odds of meeting goals. As a client's situation changes, the program keeps track of his or her progress toward these goals.

What sets his service apart from others, argues Loeper, is a move away from numbers -- a more client-centered approach instead of an "oversimplified" risk-vs.-return analysis. Risk is often measured in mathematical terms, "but not by clients, who simply say something like, I hate risk.'" So Loeper has tried to make his program more intuitive and user-friendly. He also provides Monte Carlo simulation with AASim software, designed to "model mortality and investment risk simultaneously." He has even done his own riff, or rather, rebuttal of Modern Portfolio Theory, called Modern Portfolio Reality, which takes into account market fluctuations and standard deviations over the course of years to create efficient portfolios.

Although the online questionnaires that start the planning process with Financeware.com are simple enough for clients to use themselves, the services are designed to be used in conjunction with a planner's advice. With a mix of humility and pride bordering on arrogance, the company's mission statement says, "We support the efforts of those who seek solutions for their clients and are willing to admit that they can improve on what has been done in the past."

[quote=Beagle] Asset Allocation is a sales gimmick - nothing more.

[/quote]

I've seen Nobel Prize winning research   called a lot of things before, but never a "sale gimmick".

[quote=Beagle]
Look at EIAs and their popularity - same sort of high fee, low benefit product.
[/quote]

You see EIAs and and use of asset allocation as the same thing? Just where's the "high fee" structure in asset allocation?

[quote=dude]

Let me know what y'all think of the following link.

http://www.financeware.com/Ruminations/AllocationMyth.PDF

I have some more links along these lines if you're interested.

[/quote]

Also, if you read further through his article you come to the point where he says "That's not to say that asset allocation is bad...just incomplete". Well, golly, guess how you can make it "complete"? Well, you simply buy his software.... 

I use DFA and there web site. Try it you and your clients will like it!  

http://www.dfaus.com/

[quote=Beagle]Asset Allocation is a sales gimmick - nothing more.  It's a way for people to spend more time selling and less time managing portfolios.  It's not a great way for the client to get rich.
[/quote]

You concentrate positions to get rich (ie. entreprenuership or stock options), you diversify to stay rich (ie. real estate, art, equities and bonds....not 1000 positions in 20 different SMAs ).  I've seen other advisors portfolios that have micro cap, mid cap value, large cap growth, etc, etc, etc. Clients complain that they get too much mail from confirms, proxys and annual reports for the measely 124 shares of this and 87 shares of that.

My clients are already rich when I contact them. Since I don't handle thier real property or art collection, I manage equities for them.  For me, and for them,  25 positions is enough create a meaningful portfolio.  In addition I add fixed income or international portfolios thru ETFs or mutual funds.   

[quote=skeedaddy2]

 Clients complain that they get too much mail from confirms, proxys and annual reports for the measely 124 shares of this and 87 shares of that.

[/quote]

None of my clients get those unless they ask for them. I agree with you, they can be buried under paperwork, but again, only if they ask for it.

Hey Mike, how were your holidays?

As for asset allocation being nobel prize winning research:



Yes, it was prize winning research but even Markowitz has said that it
is being used incorrectly by the industry.  Every planner sells
their clients that they can optimize their portfolio to make it so much
better than you’d ever be able to do it on your own.  That’s
BS.  Is standard deviation risk?  Yes if you believe the
industry, no if you are living in the real world.



It began as valuable research and turned into a sales gimmick. 
CAPM is great research but it’s worthless in reality.   How
many wealthy people do you know who care where their portfolio lands on
the optimization frontier? 



Asset allocation is all fine and good, it’s an important byproduct of
good portfolio management but it’s a small detail people are selling as
nuclear science.



And yes asset allocation is expensive.  People are selling this
stuff in wrapped mutual fund programs charging 1.25% per year to do an
automatic rebalance of portfolios.  Show me a research report
where automatic reblancing of portfolios to optimize the asset
allocation of the portfolios leads to better investment returns.



Or maybe you are still selling your clients on that report that 91% of
their portfolios return comes from portfolio allocation?  Another
report full of false information.



It’s just like Monte Carlo programs.   oohhhhh  yeah, that’s a great selling took that means squat in reality.

<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

[/quote]

It can be used incorrectly, that doesn’t mean there’s something wrong with asset allocation, just that there’s something wrong with misusing it. You can misuse many great things.

[quote=Beagle]

Every planner sells their clients that they can optimize their portfolio to make it so much better than you'd ever be able to do it on your own.  That's BS. 

[/quote]

Any advisor who doesn’t think they can do better than the client on his own would do (and there are truckloads of studies about how poorly individuals do on their own) should leave the business.

[quote=Beagle]

Is standard deviation risk?  Yes if you believe the industry, no if you are living in the real world.

[/quote]

Of course sd, as a measure of how far a portfolio has/can move (no one’s ever complained to me about upside volatility  ) is a measure of risk.  I don’t know how you can say otherwise if you know what you’re talking about.

[quote=Beagle]

CAPM is great research but it's worthless in reality.   How many wealthy people do you know who care where their portfolio lands on the optimization frontier?  [/quote]

Most that I talk to do. Especially when we review what happened to non-diversified portfolios since 1999 versus diversified ones.

[quote=Beagle]

Asset allocation is all fine and good, it's an important byproduct of good portfolio management but it's a small detail people are selling as nuclear science.

[/quote]

Could you explain this one further? What's "good portfolio management" as you define it?

[quote=Beagle]

And yes asset allocation is expensive.  People are selling this stuff in wrapped mutual fund programs charging 1.25% per year to do an automatic rebalance of portfolios. 

[/quote]

No, the program you’re talking about may be expensive, but that’s that particular vehicle, not asset allocation itself. ANd even comparing that to a EIA, as you did, is being less than serious

[quote=Beagle]

Show me a research report where automatic reblancing of portfolios to optimize the asset allocation of the portfolios leads to better investment returns.

[/quote]

You mean something beside MPT that details the risk of being too heavily weighted in a given sector, much less one that’s been “hot” enough lately to outgrow initial weighting given it? That should be pretty self explanatory. I will agree with you that auto rebalancing is little more than a specific discipline to force rebalancing.

[quote=Beagle]
Or maybe you are still selling your clients on that report that 91% of their portfolios return comes from portfolio allocation? 

[/quote]

That’s a good explain of the loose use of language that Markowitz was talking about. If you’re going to use his work you have to be specific about the conclusions he reached.

[quote=Beagle]

It's just like <?:namespace prefix = u1 /><?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Monte Carlo programs.   oohhhhh  yeah, that's a great selling took that means squat in reality.


[/quote]

Again, I disagree.  While you have to be specific in explaining to clients what Monte Carlo can and can’t be expected to do, but that doesn’t mean they’re useless. For all the faults in it it’s still far better than the predictability of buying into a “I’ll make you money, I have a system, never mind the underpinnings of how” sales pitch.

Beagle, btw, I appreciate the civil tone. I'll try to do my part to maintain it

That's an old article and when it was written (1999) there were many other similar ones along the lines of "the death of asset allocation".  At that time throwing darts at anything with a "dot com" got you 100% short term returns.  It was a difficult time for advisors using a planning/asset allocation approach, with clients saying "what you're doing for me is all fine and good, but my buddies are buying stocks & getting 70% gains.  Give me some of those!"

With the dot com bust that all changed, of course.  (Remember the jokes about how someone's 401K became a 201K?)  Planners/asset allocators didn't hurt their clients who stayed the course & they didn't burn up their books.  Our clients survived that bust, and they're still with us.  Those that might have taken some of their money away from us at the time are back (but with pennies on the dollar of what they took away).  We also got many new clients who fell into the trap (either themselves or through their brokers) of chasing the hot dots.

I certainly don't believe asset allocation will necessarily give anyone the best returns at any point in time.  But, for serious money at least for me it has proven to be a valuable method to preserve and enhance my clients' wealth, and to do so with a very manageable level of risk appropriate for each client.

Maybe there are those that can consistently pick the best performing asset class at any point in time, but it's not me and I have yet to find that person.

[quote=dude]

Let me know what y’all think of the following link.

http://www.financeware.com/Ruminations/AllocationMyth.PDF

I have some more links along these lines if you’re interested.

[quote=Duke#1]

That's an old article and when it was written (1999) there were many other similar ones along the lines of "the death of asset allocation".  At that time throwing darts at anything with a "dot com" got you 100% short term returns.  It was a difficult time for advisors using a planning/asset allocation approach, with clients saying "what you're doing for me is all fine and good, but my buddies are buying stocks & getting 70% gains.  Give me some of those!"

With the dot com bust that all changed, of course.  (Remember the jokes about how someone's 401K became a 201K?)  Planners/asset allocators didn't hurt their clients who stayed the course & they didn't burn up their books.  Our clients survived that bust, and they're still with us.  Those that might have taken some of their money away from us at the time are back (but with pennies on the dollar of what they took away).  We also got many new clients who fell into the trap (either themselves or through their brokers) of chasing the hot dots.

I certainly don't believe asset allocation will necessarily give anyone the best returns at any point in time.  But, for serious money at least for me it has proven to be a valuable method to preserve and enhance my clients' wealth, and to do so with a very manageable level of risk appropriate for each client.

Maybe there are those that can consistently pick the best performing asset class at any point in time, but it's not me and I have yet to find that person.

[/quote]

As usual, Duke says what I'd like to say, and in a far more diplomatic fashion. 

Standard Deviation shows volatility but is that the same as risk? 
For you maybe.  To me it’s volatility and to me volatility isn’t
risk, it’s opportunity I try to utilize.  Warren Buffet and Steven
Markel have spoken on this recently.



In 1987-1989 I spent several hours per week with my finance professors
building a software program to build optimum portfolios using
MPT.  After 2 full years of backtesting and statistical work they
compared our data to that of another university doing very similar
work.  Both teams came to the conclusion that it didn’t work very
well.  The result is a portfolio that performs well enough but the
fees and taxes (if applicable) will over power the long term
performance of picking an average mutual fund with lower expenses and
tax maintenance. 



When I did the study courses for the CFP, all but one of the
instructors had come to the same conclusion and were more interested in
selling financial planning and deteremined asset management was an easy
sell to pay the bills.



Asset allocation is all well and good and my clients receive it but I
use a form of tactical asset allocation with long term goals in mind to
outperform the market.  There have been several studies showing
that by limiting your asset classes and managing the asset allocation
accordingly, you increase your odds of achieving excess market
returns.  I’m not talking an outperformance of 5-6% per year, I’m
talking 1-3% per year over long periods of time, enough to offset my
fees and benefit the client.



My bashing of asset allocation is more along the lines of what
Skeedaddy is doing.  It looks good in theory and increases sales
but in about 10-15 years if you’ll look back at the portfolio, the odds
are overwhelming that the portfolio has underperformed after taking
into account taxes and fees.  How is this buy what’s hot and sell
what’s down practice different than buy high / sell low?



My bashing of EIAs is more to do with the fact that the selling
practices are very similar to that of asset allocation selling. 
With this awesome product you will earn solid returns with zero
risk.  Except after fees the solid returns are a whisper of what
they could have been and over 10 years the zero risk guarantee is
virtually worthless.   Cut the commissions on EIAs in half and I
bet 95% of the sales would shift to a different product.  It’s a
gimmick product that is easy to sell but isn’t generally in the best
interest of the client.



And yes I will agree with you that a bad professional is probably going
to out perform the average professional just because they keep them
invested.  But history shows that a buy and hold investor that
buys an S&P 500 index fund has a pretty darn good chance of
outperforming any professional over 20 years after taking out fees and
taking taxes into consideration.



As for my portfolio management, I don’t share it really - sorry. 
Back in 1991 I was introduced to an old guy in our area with an
absolutely awesome track record.  I paid him to teach me over the
course of a year how he invests and how he designs his
portfolios.  Best investment I ever made in my career but it
didn’t turn me into a better salesman which is something I could use.

That's interesting. I've sold some EIA's to people who are happy with the prospect of earning an average annual return of 6-8%, tax deferred, with a principal guarantee. I'm happy with the 10% commission, paid out at 100%.

Dirk,

I hope you're joking about the EIA.  Tell me how you can predict that the EIA is going to provide your quoted returns.  You know the market would most likely have to return 11% to 14% (compounding annual) over the EIA's "snapshot" period to get those returns if it is of the "quarterly averaging" style (I've done the math on a few of these things before).  Your figures are  most likely using past #'s which happen to cover one of the "richest" periods for stock market returns (last 20 years) in history.  Not likely to repeat, at minimum it is not a good idea to set your client's expectations so high

beagle,

Thanks for the comments, you are echoing my thoughts.  Although I'm somewhat of a hypocrite since I have used asset allocation as a selling tool extensively, but it's all I know. 

MikeButler

I understand where your coming from, believe me I was virtually brainwashed by the Morgan Machine (where I was trained) and they HAMMERED the asset allocation concept home. 

I'm beginning to get a little sceptical of what Wall Street wants us to sell though.  Wall Street cares about making as much money with as little trouble as possible.  Just like most things, if you were doing asset allocation 10 years ago before it was fad you did right, if you were doing the fad of the day you did wrong.  What is the fad of today?

[quote=dude]

MikeButler

I understand where your coming from, believe me I was virtually brainwashed by the Morgan Machine (where I was trained) and they HAMMERED the asset allocation concept home. 

[/quote]

Give me some credit, Dude  I've been around the block and I didn't come to asset allocation due to brainwashing, I came to it when I saw people over and over again chase "hot dots", be they individual stocks or mutual funds. Asset allocation gets you away from "hot dots" and for all the faults it works well. To me it's like Churchil's comment on democracy, it's the worse form of govern, aside from all the others.

[quote=dude]

I'm beginning to get a little sceptical of what Wall Street wants us to sell though. 

[/quote]

You always should be. But remember, this one's a process, not a product.

[quote=dude]

Wall Street cares about making as much money with as little trouble as possible.  Just like most things, if you were doing asset allocation 10 years ago before it was fad you did right, if you were doing the fad of the day you did wrong.  What is the fad of today?

[/quote]

Sorry, but there's just no way to call asset allocation a fad. EIAs may be a fad, chasing "hot dots" is nothing more than chasing the latest, invogue investment style (Buffet wasn't an idiot in the 1990s, momentum style managers aren't idiots now), GMIB are surely fads.

[quote=Beagle]Standard Deviation shows volatility but is that the same as risk?  For you maybe.  To me it's volatility and to me volatility isn't risk, it's opportunity I try to utilize.  Warren Buffet and Steven Markel have spoken on this recently.[/quote]<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Clients, without a doubt, see downside volatility as risk. If you're saying that a given sector or stock experiencing downside volatility can be a buying opportunity, I would agree. That’s exactly what rebalancing forces you to do, buy those assets experiencing the downside and sell those on the up.

[quote=Beagle]In 1987-1989 I spent several hours per week with my finance professors building a software program to build optimum portfolios using MPT.  After 2 full years of backtesting and statistical work they compared our data to that of another university doing very similar work.  Both teams came to the conclusion that it didn't work very well.  The result is a portfolio that performs well enough but the fees and taxes (if applicable) will over power the long term performance of picking an average mutual fund with lower expenses and tax maintenance.  [/quote]

Given that MPT, in its most strict form is balancing varying indexes (remember, MPT holds that active management can’t beat indexes for any real length of time) I have no idea how you could have used it to develop a portfolio that had a drag in fees and taxes. You might want to contact the Nobel Prize committee.  You might also want to detail these fees and taxes you constantly reference. It isn't as if the average mutual fund doesn't generate taxable events and require a fee.

[quote=Beagle]When I did the study courses for the CFP, all but one of the instructors had come to the same conclusion and were more interested in selling financial planning and deteremined asset management was an easy sell to pay the bills. [/quote]

That’s interesting, because not one of my instructors cared about the “business end” of being a CFP or commented on selling (it’s not part of the exam) and they all were the most radical adherents of MPT you’d ever hope to meet. The considered active management to be akin to theft and felt every client could be best helped with a portfolio of index funds (not very many ETFs at the time) in a tailored asset allocation model.

[quote=Beagle]Asset allocation is all well and good and my clients receive it but I use a form of tactical asset allocation with long term goals in mind to outperform the market. 

[/quote]

Most advisors I know do the same, mixing strategic and tactical asset allocation efforts. That’s why so many have been light on fixed income for years, regardless of what the models have said.

 [quote=Beagle]
My bashing of asset allocation is more along the lines of what Skeedaddy is doing.  It looks good in theory and increases sales but in about 10-15 years if you'll look back at the portfolio, the odds are overwhelming that the portfolio has underperformed after taking into account taxes and fees. 

[/quote]

I assume you’re being critical of asset allocation and not Skeedaddy, since it’s not exactly clear. If that’s the case you’re making assumptions about fees and taxes that I doubt you can support. Your clients pay taxes and they pay you a fee, I assume.

[quote=Beagle]
My bashing of EIAs is more to do with the fact that the selling practices are very similar to that of asset allocation selling. 

[/quote]

Oh, come on. I’ve been able to see your position up to this one. EIAs are a product, not a process and they’re just shy of legalized theft given their high fees and low real return (by return I mean “risk free” nature, as most any portfolio, well balanced and held long as the 10 year surrender of those things can be expected to provide similar returns without that drag of the “guarantee” fees). You simply can’t say, with any real confidence, that asset allocation isn’t in the interest of the client and your broad generalizations about fees and taxes don’t hold water. How about you try getting specific on those two?

[quote=Beagle]
But history shows that a buy and hold investor that buys an S&P 500 index fund has a pretty darn good chance of outperforming any professional over 20 years after taking out fees and taking taxes into consideration. [/quote]

I disagree with that completely, but I wonder, if you believe it, how do you sell investment services thinking they have no real value? Why not tell your clients they should buy and S&P 500 fund and call it a day?

[quote=Beagle]

my portfolio management, I don't share it really - sorry.

[/quote]

So I have to defend a known thing, and you get to hide behind an alternative that remains a mystery....

[quote=Beagle]

  Back in 1991 I was introduced to an old guy in our area with an absolutely awesome track record. 

[/quote]

I remember awsome track records, in fact, I remember many. I also remember how many of those "awesome track records" disappointed when that particular investment style and capitalization went out of favor.

In fact, we could have a great day talking about the mutual funds (and I only choose funds because we all know the names and records, but the same applies to every portfolio format) that had an "awesome record" and was on everyone's "must own" list that disappointed badly in changing market conditions. Can I start? How about the Janus Fund when the market shifted from momentum investing?

[quote=Beagle]

I paid him to teach me over the course of a year how he invests and how he designs his portfolios.  Best investment I ever made in my career but it didn't turn me into a better salesman which is something I could use.
[/quote]

Ahhh, you have the black box that outperforms portfolios designed using Nobel Prize winning theory, but you can’t let us in on any of the details. Well, I don’t mean to be insulting, but I’ve seen literally thousands of little back boxes. In the form of individual managers, mutual funds, SMAs, UITs, etc., etc., etc..

It’s been my experience that over the long term black boxes tend to perform equally well, but in different patterns of being in and out of favor with the market. As I’ve said before, <?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Warren wasn’t an idiot when his Graham/Dodd style was out of favor in the 1990s, and he’s not omnipotent today. His style, like all others, goes in and out of favor with the market. Because of that I prefer to mix and match those black boxes keeping in mind their correlation and risk/reward profiles.

Mike,

Ibbotsson driven strategic allocation in one of 5 predetermined models (Agg, Mod Agg, Mod, Mod Cons, Cons), packaged into any variety of dozens of mutual fund wrap programs (fund solutions, Portfolio Architect), SMA accts, mutual fund of funds (allocator funds), lifestyle funds, ETF Wrap accts etc, etc......   These are products using asset allocation as the process.  Hot Dots were a process, albeit a process of trend following eg: look how well these companies have done let's buy them, many products were created around this process (mutual funds, uits etc...).  Asset allocation is a similar process: Hey look how well a portfolio would have done if we mixed assets in these ways.

I think that asset allocation is fine way for crappy investors like me (bad at picking stocks) (give me credit for being honest) to not blow people up, but I don't believe it's a way to get great returns either.  I guess I'm a believer that inefficiencies are out there to be exploited by those more astute than I and that whatever is now hot will one day cease to be.  Also, I don't think that mutual fund managers or most of wall street are necessarily the "smart" money either.  Their job is marketing a dream and profiting from those who want to try to participate in the dream.

Truth is, is that anyone (not just Advisors with degrees and licenses)can take the ibbotsson allocation model and plug in the proper index funds and most likely do better than most allocation products, especially if they remove me and my 1.5% fee from the equation.  Now, most of my 50 plus year old clients aren't savvy enough to go online and read a little (emphasis on little) to learn that this is essentially all I do (besides the financial planning stuff, which I'm begginning to believe is better to charge a retainer for) and charge them, Oh $3,000 (on $200,000) or more a year for, plus another $3,000 for active managers who have a very low probablity of earning that money (underperformance relative to their benchmarks).  The concern is that Gen X is savvy enough.

The truth is, is that for asset management in an ASSET ALLOCATED (I am generalizing here) fashion my clients should bypass me, since I'm not going to be doing much other than filling out a risk quesitonaire, teaching them a little and then placing them in the wrap account.  The rebalancing is automatic.  Everything else is FAT; birthday cards, client appreciation events, even the financial planning( which takes me 15 minutes of data entry, printing and binding) or the HOLY "I'm here to prevent my client from making the BIG mistake of selling when the markets are scary"  .  Well once they've filled out their risk tolerance questionaire, doesn't that take care of the BIG MISTAKE argument?  Don't you end up putting them in a portfolio that matches them with a portfolio that they are likely to hold onto.

Now, if you're a broker who researches special investment ideas and earns commissions or manages stock positions for a fee, this is different since you are actually researching, watching and positioning assets.  These are activities that seem appropriate to earn asset based fees for, whether you outperform the market or not in a given year)

Here's the argument:

A share mutual funds are the most appropriate compesation model for the majority of what brokers do when it comes to a one time education, financial planning, product sale with occassional servicing.  Compensates us for what we do based on the work involved and long term the fees are pretty darn good with the right fund families.

Fee based compensation is most appropriate for direct active asset management and family office type services (this is high end bill paying, walk your dog stuff).

Retainers are most appropriate for financial planning, manager research and recommendation.

Any thoughts

[quote=dude] <?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Mike,

Ibbotsson driven strategic allocation in one of 5 predetermined models......   These are products using asset allocation as the process. 

[/quote]

First off Ibbotsson isn't the be all and end all of asset allocation, much less is using one of five models a fine example of a refined, tailored to the client, system.  If that’s what you’re calling asset allocation we will probably agree on many of the shortcomings of that business model. Furthermore, each of the products you mentioned have pros and cons and shouldn't be lumped together any more than all mutual funds should be lumped together. Asset allocation remains a process, even is a product is stuffed into it at the very end.

[quote=dude]

 Hot Dots were a process, ….Asset allocation is a similar process: Hey look how well a portfolio would have done if we mixed assets in these ways.

[/quote]

You're confusing looking in the rear-view mirror at a handful of funds to get a big performance number that weak advisors use to “sell” clients with a process that measures the performance of market sectors (not active management) and notes the correlation between them. That’s a different as night and day.

[quote=dude]

I think that asset allocation is fine way for crappy investors like me (bad at picking stocks) (give me credit for being honest) to not blow people up, …

[/quote]

Time for a dirty little Wall Street secret. While there ARE crappy stock pickers, there are NO stock pickers, no matter how good, who look good in every market cycle. That’s why even the sainted <?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Warren looked like a clueless old man in the 1990s.

[quote=dude] …but I don't believe it's a way to get great returns either.  I guess I'm a believer that inefficiencies are out there to be exploited by those more astute than I and that whatever is now hot will one day cease to be. 

[/quote]

Not only is it  a way for great returns, it’s a way to hire experts in very narrow fields (small cap growth managers, Large cap deep value managers, etc) who can stick to what they do best, exploit those inefficiencies and you profit from it.

[quote=dude]

 Also, I don't think that mutual fund managers or most of wall street are necessarily the "smart" money either.  Their job is marketing a dream and profiting from those who want to try to participate in the dream.

[/quote]

I agree and disagree. Wall Street at large IS in marketing that dream. Individual mangers, otoh, at their best manage money and leave marketing to others. The very same criticism can be made, btw, of the guy who runs the one man shop with the black box, can’t miss, system.

[quote=dude]

Truth is, is that anyone (not just Advisors with degrees and licenses)can take the ibbotsson allocation model and plug in the proper index funds and most likely do better than most allocation products, especially if they remove me and my 1.5% fee from the equation.

[/quote]

Only if you make a habit of employing in your various sectors managers that can’t beat their respective indexes. While beating the S&P 500 isn’t all that easy for, say a large cap growth manager, many do it regularly and when you’re talking about other indexes, like the S&P 400 and 600 or the EAFE, there are mangers running money in those sectors that beat the indexes like a drum day in and day out.

[quote=dude]

and charge them, Oh $3,000 (on $200,000) or more a year for, plus another $3,000 for active managers … [/quote]

You’re charging 3% on 200k accounts? No wonder you worry about the drag of fees. BTW, if your managers can’t beat their respective indexes, look for others who do.

[quote=dude]

The concern is that Gen X is savvy enough.

[/quote]

Yeah, that’s why study after study show they buy at the top and sell at the bottom.

[quote=dude]

The truth is, is that for asset management in an ASSET ALLOCATED (I am generalizing here) fashion my clients should bypass me, ……"I'm here to prevent my client from making the BIG mistake of selling when the markets are scary” [/quote]

First, no, you don’t end up putting them in portfolios so tame that they’re never tempted to sell in “scray markets”. Don’t under estimate the damage they can do to themselves with “the big mistake”. Ask Duke again about the “Yeah, but you’re only making me 20% with your balanced portfolio and I want to put it all in the Janus Fund and make 67%” clients. If you’re like me you’ve saved them DECADES worth of what they pay me by keeping them from financial suicide. Having said that, honestly, if that’s all you do, you aren’t giving them what they’re paying for. You job is more than filling out questionnaires and holding hands..

[quote=dude]

Now, if you're a broker who researches special investment ideas and earns commissions or manages stock positions for a fee, this is different since you are actually researching, watching and positioning assets.

[/quote]

I’d say that’s an investment advisor who thinks they’re a portfolio manager (such is a subset) or an analyst. Every firm (and by all means, don’t use ONLY your firm’s work) has people already doing that and unless you’re a CFA with decades in the business you won’t do their job better than they do. I’d suggest you pay that very same sort of attention you say stock pickers do and spend that time researching the managers you can hire (I’m talking SMAs here), their philosophies, strategies and histories so you can really understand the slices of the pie you’re showing to clients. Once you grasp the deep differences between them all and how their work coalesces in a portfolio you really aren’t doing much more than filling out a foem and using one of five asset allocation models.

[quote=dude]

Here's the argument:

A share mutual funds are the most appropriate compesation model for the majority of what brokers do when it comes to a one time …

Fee based compensation is most appropriate for direct active asset management ….

Retainers are most appropriate for financial planning, manager research and recommendation.

Any thoughts

[/quote]

Yeah, tell me more about your retainer idea, and tell me why it’s more work and more appropriate for fee compensation to say to a client “Let’s buy 100 shares of HD” than it is to research and know in depth the appropriate managers (again, SMA) and combinations to get the job done in a portfolio? What makes the former appropriate for fees and the latter only a retainer issue? Aside from that, I think we agree on a lot.

Beagle & Mike, you guys are giving us a great exchange of thoughts.  Good, fair debate without getting nasty or personal.  Thanks for this, and for setting a high standard for the forum.  Keep it up.

I echo Dukes thoughts.  Thanks for the candor.

Beagle:

I know you don't want to share your secrets, but would you mind giving us an idea of some of the process you use for portfolio management without disclosing your secret sauce?  I appreciate your critisisms and insight (many of which I agree with), it's just that I don't come here to engage in ego fufilling debate, but instead to improve upon my process and learn (and hopefully help others do the same).  Can you make any suggestions on what a better process might be?  Thanks in advance for any thoughts you have to share.

Note:  Beagle, I’m not suggesting that you come here for ego fufilling debate (just noticed that my post imply’s that, sorry).

[quote=Duke#1]Beagle & Mike, you guys are giving us a great exchange of thoughts.  Good, fair debate without getting nasty or personal.  Thanks for this, and for setting a high standard for the forum.  Keep it up.[/quote]

I second that comment....

[quote=mikebutler222]

[quote=dude]

and charge them, Oh $3,000 (on $200,000) or more a year for, plus another $3,000 for active managers … [/quote]

You’re charging 3% on 200k accounts? No wonder you worry about the drag of fees. BTW, if your managers can’t beat their respective indexes, look for others who do.

[/quote]

I would have expected better math skills from someone that posts as much as you

[quote=mikebutler222]

Beagle, btw, I appreciate the civil tone. I’ll try to do my part to maintain it

Gentlemen,

I thought you would get a kick out of this since we’re picking on Janus:



(numbers thru sometime in 2001)

Value Fund/Janus Fund     Style   &nb sp; 5-Year      Return (% annlz’d)



Ameristock (AMSTX)        Large -cap value         & nbsp;   21.67%

Janus Growth & Income (JAGIX)     Large-cap growth     21.65%



Selected American (SLASX)     Large-cap value     20.13%

Janus Mercury (JAMRX)     Large-cap growth              20.01%



Excelsior Value & Restruct (UMBIX)     Large-cap value21.08%

Janus Twenty (JAVLX)     Large-cap growth              19.94%



Nations Intl Value A (EMIEX) Lge-cap value (Foreign)     18.97%

Janus Overseas (JAOSX)     Lge-cap growth (Foreign)     18.58%



Investment Co of America (AIVSX) Large-cap value     16.62%

Janus (JANSX)     Large-cap growth                              16.32%



Amer Century Target 2020 (BTTTX)     Government Bond 11.01%

Janus Venture (JAVTX)      Small-Cap Growth                  10.99%





As far as I remember, the biggest mistake Janus made was maintaining

an overconcentration in tech & telecom. It turned out that many of the 19

funds they managed had the same positions, which can be easy if all the

fund managers shared the same trading floor and attended the same

company presentations. It was a call made by management to overweight

the same names throughout the funds and they paid for that mistake.



Janus also has a series of offshore (registered) funds available only thru

B/Ds. I still have some Janus Technology in my book and it has recovered

very nicely since the debacle. Here was an occassion when I wore my

"value" hat.



When I was at Oppenheimer & Co, the chief strategist, Mike Metz (a

disciple of Graham & Dodd) also discounted the dot coms and advised

investors to overlook them. Meanwhile, every time I signed on to the

internet (dial-up back then) I always ended up looking at the Yahoo front

page. Yahoo went from about $4 to $150, and I and my clients missed it.







If I understand Dude’s point we should be wary that retail Wall Street

(banks and indepedents too) are pushing, I mean directing, us to maintain

broadly diversified portfolios and wrapping them into a fee structure.

This allows them [firms] to realize some level of efficiency and limit

litigation in the future.   But what happens if after 5,6 or 10 years of the

market treading water? Will clients be inclined to try to recover fees in a

lawsuit for underperformance?

Thanks Skee for simplifying my thoughts.

Mike,

Maybe I'm wrong on this, but the whole idea of receiving ongoing fees for overseeing managers and hiring / firing managers seems futile.  Almost all research shows that the vast (and I mean vast) majority of managers underperform the market and those who reach the upper deciles of performance do not stay there long (except for a statistically insignificant minority).  What REAL value are we bringing to the table by hiring/firing managers? (the only ongoing service I can identify directly related to asset managment under a wrap type program that we provide outside of the financial planning etc..)  To me it seems like rearranging chairs on the titanic.

Ok, so let's say that we choose to do indexing w/in a wrap program.  After we set the model in place what are we being compensated for? automatic rebalancing ? Certainly not manager selection.   

If you are doing tactical allocation, by altering sector weightings etc... that is a role and activity akin to stock picking in that it proposes that you can add value by knowing what sectors/asset classes will outperform (which you might, but alas just like most forecasting tends to have similar results i.e. not great).  In that case, you can make a better justification for charging a fee since there is a more direct ongoing relationship between you and the clients $$$, whether or not your results are better than passive management (although if you keep on underperforming and the client cares, you might loose the client)

the #'s break down this way:

$200k @1.5% for me (the other $3,000 was 1.5% for the mutual fund managers which might be high, fine let's not split hairs) is $3000

over 10 years assuming 10% annual growth my total fee will be $47,809 (not taking into account taxes eroding portfolio etc...)

Do you really think over the next 10 years you have the ability to select the managers that make up for the extra cost of your fee?  If your crystal ball works that well for managers, why not stocks? 

The truth will probably be that the managers you pick will perform about as well as the rest over a ten year period minus your fee. 

NOW THE OTHER SCHOOL OF THOUGHT GOES THIS WAY:

We are not trying to beat an index, we are measured against how the client does relative to their goals.  Fine.  How about this thought:

The more cost you layer onto the clients $$ the lower the probablity you have of meeting their goals.  Especially if the market does not deliver the expected results.

Also, how do you justify a % fee annually for sitting on the $$$.  I'm going to assume if you subscribe to the above you don't hire a money manager based on how well he/she does relative to a benchmark?  If you do see above.

HERES WHY A RETAINER SEEMS APPROPRIATE FOR MOST OF THE VALUE ADDED SERVICES WE PROVIDE FOR THE %FEE:

When you do a financial plan you are giving the client a roadmap based on generally a couple hours work, until it is updated (which usually won't be very frequent) there is nothing else to do if you subscribe to the general wrap investment idealogy.  Let others do the work (money managers).  Why are we getting paid an override on an activity we are adding little value to (asset management).  We should get paid for the value we are providing wouldn't you agree?

[quote=skeedaddy2]Hey Mike, how were your holidays? [/quote]

Great, thanks for asking. How were yours?

Mine were good, too. My holidays are Christmas and New Years. Is it ok to say “Christmas” on this board?

[quote=jonesnewbie][quote=mikebutler222]

[quote=dude]

and charge them, Oh $3,000 (on $200,000) or more a year for, plus another $3,000 for active managers … [/quote]

You’re charging 3% on 200k accounts? No wonder you worry about the drag of fees. BTW, if your managers can’t beat their respective indexes, look for others who do.

[/quote]

I would have expected better math skills from someone that posts as much as you

[/quote]

See if you can follow me here, Jonsie;  $200K charged at a rate of ($3k+$3k) =

3%. Got it?

[quote=Beagle] [quote=mikebutler222]

Beagle, btw, I appreciate the civil tone. I'll try to do my part to maintain it

[/quote]

And then you say a one man shop with a black box system that can't miss.

The two don't add up.

[/quote]

Sorry, you make a good point there.

[quote=Beagle]

My CFP instructors all knew that in the best sense, they could earn for their clients 80-90% of what the market earns after their fees.

[/quote]

That fairly sums up the opinion of those of the "absolute MPT" camp (but they‘d say 99% after their 1% fee) . My instructors were college profs, and they believed it with their heart and soul. They were, of course, wrong. Hell, they couldn't even define "the market" beyond the S&P 500.

[quote=Beagle]

This is why most "financial planners" sell financial planning instead of asset management.

[/quote]

I disagree. Most sell planning and not management because 1) They're hard core MPT or 2) they don't have the tools or the inclination to actually manage money.

[quote=Beagle]

When you consider the fees and taxes their portfolio adjustments generate, it's a hard sell to say they can outperform the market so most don't even try. They argue passive investing is the only "fiduciary" option but we know better right?

[/quote]

Again, I disagree. The ones that do it are hard core MPT types who use indexes, by and large, get paid a fee for it and cause the minor taxes that rebalancing causes as the cost of staying in compliance with MPT. It isn't as if they just buy the S&P 500 and take nap.

[quote=Beagle]

The way you discuss money managers - we've found something we can agree upon I'm guessing.


[/quote]

Maybe we have a misunderstanding here. I believe in active management, I simply want to see a number of different managers with differing styles at work in a given portfolio.

[quote=skeedaddy]Gentlemen,
I thought you would get a kick out of this since we're picking on Janus:

(numbers thru sometime in 2001)

[/quote]

You mean numbers since sometime in 2001?

[quote=skeedaddy]

As far as I remember, the biggest mistake Janus made was maintaining an overconcentration in tech & telecom.

[/quote]

They were over concentrated because they were buying momentum stocks, which largely happened to be in those two areas. BTW, I didn't mean to pick on Janus alone. I could just as easily mentioned any number of different funds during different periods. It's you're old enough in the business you can remember when the hot dot was Peter "You can't beat him" Lynch at the Magellan fund. Or when Warren Buffett went from being the Oracel of Omaha to dunce and back again to god on earth. It was due to investment styles going in and out of favor, not some incredible genius and then overwhelming ignorance on their part.

[quote=skeedaddy]
When I was at Oppenheimer & Co, the chief strategist, Mike Metz ..."

[/quote]

Metz the megabear. Sour all through the 1990s bear market. The Stephen Roach of his day. Mr Sunshine....

[quote=skeedaddy] But what happens if after 5,6 or 10 years of the market treading water? Will clients be inclined to try to recover fees in a lawsuit for underperformance? [/quote]

"The market" may be treading water, but diversified portfolios aren't. I find it interesting that by "the market" people often mean the S&P 500 and perhaps the DOW as if the S&P 400 and 600, not to mention EAFE and emerging markets didn’t exist. Well, they do exist and they've been beating the daylights out of the growth oriented 500 for five years now.

MPT is not “modern”. Was promulgated in the 50’s. Go ahead and index. Still under water after past SIX years. Or better yet…“buy and hold”. Didn’t hear much about that in the 60’s and 70’s. Actuality is that nothing works for long. If it did, everyone would do it and…guess what? That wouldn’t work either. Most people with real dough are interested in capital preservation. Watch their eyes glaze over if you do the gobbledygook thing.

[quote=dude]

Almost all research shows that the vast (and I mean vast) majority of managers underperform the market and those who reach the upper deciles of performance do not stay there long (except for a statistically insignificant minority). [/quote]

That's just not true. That thinking is an outgrowth of skewed studies by hard core MPT types who "prove" most mutual funds don't beat the S&P 500 by lumping in all sorts of funds that don't aim to beat the 500, like income oriented funds, balanced funds, etc.. And while beating the 500 IS a challenge for large cap managers, beating the 400, 600 and EAFE indexes is a far easier matter for managers specializing in those areas.

[quote=dude] What REAL value are we bringing to the table by hiring/firing managers?

[/quote]

You mean besides watching for style drift, changes in management teams, how they perform against their peers, etc.? Ever read an attribution report on a manager?

[quote=dude]

"Ok, so let's say that we choose to do indexing w/in a wrap program. After we set the model in place what are we being compensated for? automatic rebalancing ? Certainly not manager selection."

[/quote]

Why do you laugh at rebalancing? Sectors perform in differing manners and they should be readjusted. Don't act as if that's nothing, and don't act as if monitoring both the portfolio and the client's goals and needs doesn't count for anything either. Having said that, I have some accounts where the client wants to use ETF indexes and I usually do that on a commission basis unless they prefer otherwise.

[quote=dude]

If you are doing tactical allocation, by altering sector weightings etc...

[/quote]

I think I mentioned in another post that I do, and most other I know, do do that. We're certainly not using one of five cookie cutter allocations from a ten question form.

[quote=dude]

the #'s break down this way:

$200k @1.5% for me (the other $3,000 was 1.5% for the mutual fund managers which might be high, fine let's not split hairs) is $3000

[/quote]

As I read your other post I thought I saw 3K for you and 3k for managers (mutual funds wasn‘t what I was considering) . That's 3% and mighty high. Let me mention again I don't use mutual funds for this. They're too expensive and too prone to style drift and holding cash not to mention that you have no control of taxes. Using SMAs I'll do an account all in for 2% max.

[quote=dude]

Do you really think over the next 10 years you have the ability to select the managers that make up for the extra cost of your fee?

[/quote]

Even if that was the only thing I did for the client, the answer is, oh, yes.

[quote=dude]

If your crystal ball works that well for managers, why not stocks?

[/quote]

If you believe in asset allocation and the underpinnings of style purity and capitalization weighting, you have to ask when you see a one man portfolio, is he a large cap growth guy, a small cap value guy, an emerging market guy? I don't believe one manager can do it all. I mean, Dr. J was a great ball player, but he wasn't the best power forward AND center AND guard. Hell, in fact, even most guards can't play one guard AND two guard equally as well.

[quote=dude]

We are not trying to beat an index, we are measured against how the client does relative to their goals. Fine. How about this thought:

[/quote]

I think this is where a lawyer would say you're assuming facts not in evidence. Also, I measure portfolios against a blended index that consists of the equivalent weightings of the sub indexes, EAFA, 400, 600, etc., not the S&P 500.

[quote=dude]

Also, how do you justify a % fee annually for sitting on the $$$. I'm going to assume if you subscribe to the above you don't hire a money manager based on how well he/she does relative to a benchmark? If you do see above.

[/quote]

I don't quite follow that, but "sitting on the money" is not something I do.

[quote=dude]

Why are we getting paid an override on an activity we are adding little value to (asset management). We should get paid for the value we are providing wouldn't you agree?

[/quote]

Again, you're assuming facts not in evidence. I simply disagree with you about the value of manager selection and monitoring, actually building the portfolio to fit the client’s needs, goals (not to mention helping the client identify and detail those goals and needs) and tolerances, tactical allocations, keeping the client from blowing himself up when the market makes him sick, etc., etc,. etc..

Dude, have you had a chance to do any work towards a CIMA designation? You might find it could change your views on a couple of these issues.

[quote=Revealer]MPT is not "modern". Was promulgated in the 50's. Go ahead and index. Still under water after past SIX years. .[/quote]

I haven't seen a single SMA portfolio built using asset allocation or MPT underwater the last six years. Most are up 10% or more on an annualized basis.

Those performance numbers I posted were for 5 years ending in 2001. The significance of this was to capture the dot.com bubble in the returns.  I thought it was curious that these "value" funds were basically in line with the "growth" funds, and that the govi fund did as well as the small cap fund. What a hoot!  

Again further evidence supporting my previous posts that I've
noticed that during the same market periods some "value" managers
outperform "growth" managers and vice versa.

One could conclude then that this argument of which investment style is better or in favor or out of favor is bogus.  If an investment style is in fact in vogue, then the other style can't do as well. The words value, GARP and growth have become branding words. 

Jamming clients into pre-determined allocation models in order to simplify the process and maximize efficiency is not appealing to me. And as far as "financial planning", I ask how can calculating net worth, life expectancy and time value of money have to do with investment success? 

For purposes of a financial plan, a typical analysis: 1. assumes tax bracket, 2.assumes inflation rate, 3. assumes risk-free returns, 4. assumes equity risk premium and finally 5. assumes that previous investment results will be obtained in order to determine an optimum investment blend. 

Now let me get back to work. My Nordstroms is on fire today.

MikeButler said:

We are not trying to beat an index, we are measured against how the client does relative to their goals. Fine. How about this thought:

I think this is where a lawyer would say you're assuming facts not in evidence. Also, I measure portfolios against a blended index that consists of the equivalent weightings of the sub indexes, EAFA, 400, 600, etc., not the S&P 500.

Reply:

You took this out of context, there is more directly above it that is detailing various arguments and justifications for an  asset allocated approach.  I'm not pointing any fingers at you, just addressing what I have seen to be the vast majority of variations on this theme. 

[quote=skeedaddy2] <?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Those performance numbers I posted were for 5 years ending in 2001. The significance of this was to capture the dot.com bubble in the returns.  I thought it was curious that these "value" funds were basically in line with the "growth" funds, and that the govi fund did as well as the small cap fund. What a hoot!  

[/quote]

Thanks for making that time period clear, and you  make a good point. Especially during that time period when value managers fled a value philosophy and started buying growth stocks and/or became stealth index funds because they got tired of getting beaten-up in a marketing environment where style didn’t matter to the buyer (and therefore didn’t matter to the seller) and every fund was compared to the S&P 500 or the hottest of the hot dot. If I heard it once then I heard it a thousand times, "let’s dump all this Warren Buffett style junk and load up on (fill in hot dot fund name here).”.

The key is to stay away from managers who are able to drift in style (as most fund managers are), a classic example would be the guy running the Legg Mason “Value” Fund that was buying Cisco at the top as a “value” stock.

[quote=skeedaddy2]

One could conclude then that this argument of which investment style is better or in favor or out of favor is bogus.  If an investment style is in fact in vogue, then the other style can't do as well.

[/quote]

One could, but one would be wrong .      That’s the danger of using the name of a style drifting fund to ascribe some real style definition. For a clearer case, look at the style and cap indexes, Russell or S&P to get a real picture where marketing induced style drift isn’t present. There you'll see significant differences.

[quote=skeedaddy2]

Jamming clients into pre-determined allocation models in order to simplify the process and maximize efficiency is not appealing to me. 

[/quote]

Or me, see the post with Dude on that subject.

[quote=skeedaddy2]

And as far as "financial planning", I ask how can calculating net worth, life expectancy and time value of money have to do with investment success? 

[/quote]

If you define “success”, as I do, which is did we succeed in achieving a specific client’s specific financial goals, those things are critical. If “success” is posting a number without consideration of the risk involved or what the client needed that money to do (income, wealth preservation, capital appreciation, etc..) then those things don’t matter.

[quote=skeedaddy2]

For purposes of a financial plan, a typical analysis: 1. assumes tax bracket, 2.assumes inflation rate, 3. assumes risk-free returns, 4. assumes equity risk premium and finally 5. assumes that previous investment results will be obtained in order to determine an optimum investment blend. 

[/quote]

Those are assumptions made on a reasonable basis based on reasonable criteria. While they may not constitute a promise, it’s far better to use them than to say they can’t be known to exacting specificity and therefore ignore them. It’s akin to saying flying by instrument isn’t perfect, and therefore venturing off into the night flying completely blind instead.

[quote=dude]

MikeButler said:

We are not trying to beat an index, we are measured against how the client does relative to their goals. Fine. How about this thought:

I think this is where a lawyer would say you're assuming facts not in evidence. Also, I measure portfolios against a blended index that consists of the equivalent weightings of the sub indexes, EAFA, 400, 600, etc., not the S&P 500.

Reply:

You took this out of context, there is more directly above it that is detailing various arguments and justifications for an  asset allocated approach.  I'm not pointing any fingers at you, just addressing what I have seen to be the vast majority of variations on this theme. 

[/quote]

I just took it as I read it, and it would seem I misunderstood your point. Could you try me again on it?

Ohhhhh…Barf!

[quote=dude]

MikeButler said:

We are not trying to beat an index, we are measured against how the client does relative to their goals. Fine. How about this thought:

I think this is where a lawyer would say you're assuming facts not in evidence. Also, I measure portfolios against a blended index that consists of the equivalent weightings of the sub indexes, EAFA, 400, 600, etc., not the S&P 500.

Reply:

You took this out of context, there is more directly above it that is detailing various arguments and justifications for an  asset allocated approach.  I'm not pointing any fingers at you, just addressing what I have seen to be the vast majority of variations on this theme. 

[/quote]

 Well, I went back to your post and read it. I suppose my answer is the same, just more clearly worded; I simply reject the underlying assumptions of the other school of thought. Many managers DO, REGULARLY beat the index they should be compared to. It’s a matter of knowing who those managers are, how they do what they do, what market cycles favor them and don’t, and how to combine them with other managers.  Portfolios made up of those managers perform superbly and when priced fairly are well worth the fess involved. One thing to consider is why, even though many combine some passive investing, so many large pockets of smart money like endowments and trusts have always managed money in this fashion if it’s worthless.<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

[quote=Dirk Diggler]Ohhhhh....Barf![/quote]

You OK, Dirk? Need a hanky or a bucket?

Dirk needs a hug.

[quote=FIDO]Dirk needs a hug.[/quote]

I bet bankrep would give him a hug.....

[quote=mikebutler222]

[quote=Revealer]MPT is not "modern". Was promulgated in the 50's. Go ahead and index. Still under water after past SIX years. .[/quote]

I haven't seen a single SMA portfolio built using asset allocation or MPT underwater the last six years. Most are up 10% or more on an annualized basis.

[/quote]

avg 10% per annum?  hmmmmm......I find that a little hard to believe....

MikeB:

I was illustrating some of the justifications and/or attitudes I have heard concerning the financial planning approach, where some people say that their job is not to find managers that beat their indexes, but to help people meet their financial goals.  I say that if that is the case then they are implicitly saying that they are not adding value to the asset management aspect and should be paid a retainer for doing a plan not a % of assets annually.

In my case, to be honest, I don't believe that I have some magic formula of identifying money managers that will outperform their indices over the next 10 years. 

I can identify managers that have done it in the past (in fact I'm really good at it, with all my software and smarts ), but I don't believe that past performance (by any metric; sharpe ratio, alpha, upside/downside capture ratios, style adherence etc...) is predictive of future performance, and I believe that the vast majority of the nobel winning academics you often cite, would agree.  In fact the vast majority of research on the subject overwhelmingly supports my position, with the exception of more inefficient markets and even then I have never seen an overwhelming majority of emerging markets and small cap funds outperform their indices consistently;  usually it's pretty close to 50/50.  It would seem that the problem would be that someone who follows most allocation models would only put a small portion of the overall portfolio in those asset classes, so any outperformance would have minor effect. 

I appreciate these types of discussions, if for no other reason, because

they keep me sharp and informed. As I’ve said before, Mike, I believe that

you do an excellent job of arguing. Just a couple more years of education

and you could have been arguing before the Supreme Court.



Now it seems that you have taken it upon yourself to be the great

advocate for financial planning and asset allocation when I know that a

great many of the participants on this forum share your sentiments and

convictions. Perhaps they lack the time or the articulateness to express

their opinion. So don’t take this as a personal attack. Remember, we’re

professionals.



I had a chance to look into this debate of growth vs. value and came up

with some additional information that might be useful. Since 1980, the

correlation between Russell 1000 Value and Russell 1000 Growth is .82.

In 100 quarterly observations, they have moved in opposite directions

only 5 times or 5% of the time. Since 1979, the average annual difference

in returns between both styles has been only 2.2%.   So all this time we’ve

been splitting hairs on 200 basis points difference.



Laurence Siegel is the guy who manages $10 billion for the Ford

Foundation, who has better information and better portfolio management

capabilities than you or me, hasn’t been able to devise a trigger system to

exploite a change in leadership.



I do agree that diversification is important, it just doesn’t exist amongst

US equities. .82 correlation is not diversification to me. I’m curious does

Warren have any investments in India or China?

[quote=joedabrkr][quote=mikebutler222]

[quote=Revealer]MPT is not "modern". Was promulgated in the 50's. Go ahead and index. Still under water after past SIX years. .[/quote]

I haven't seen a single SMA portfolio built using asset allocation or MPT underwater the last six years. Most are up 10% or more on an annualized basis.

[/quote]

avg 10% per annum?  hmmmmm......I find that a little hard to believe....

[/quote]

Well, here's one right in front of me, selected at random. The allocation is (rounding off) 22.5% RV 1000, 22.5% RG 1000, 22.5% MSCI EAFE, 13% RG 2000, 13% RMCV. CISDM Public Fund Index 7% (for managed futures) These annualized index performance numbers end 6/05; 1yr 11.46%, 3 yr 11.47%, 5 yr 3.08%. The mangers’ performance (total portfolio), net, over the same period was,  1yr 13.65%, 3 yr 14.30%, 5 yr 11.91%.

[quote=dude] <?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

MikeB:

I was illustrating some of the justifications and/or attitudes I have heard .... they are implicitly saying that they are not adding value to the asset management aspect and should be paid a retainer for doing a plan not a % of assets annually.

[/quote]

You may have a point there if that's all they do. What sort of rate retainer are you talking?

[quote=dude]

In my case, to be honest, I don't believe that I have some magic formula of identifying money managers that will outperform their indices over the next 10 years. 

[/quote]

You try, sometimes you do, sometimes you don't and have to fire one. The success rates are higher than you might think, and much better, imho, than picking stocks. I have to say again, the broker that’s picking stocks is, at best, a part time player in a world of full time athletes. You’ll surely do better than the man on the street, but even if you find time away from everything else you do for a living, you can’t match the guy that sits in front of that screen all day long doing nothing but watching the 10 stocks the manager has assigned him. As an example, if something bad happens he pulls the trigger, period. You and me? We have to call the client, explain it, get his permission to sell it and face the consequences of possibly losing the account if you have to make too many of those “hey, we didn’t see it coming, but…” calls.

[quote=dude]

I can identify managers that have done it in the past (in fact I'm really good at it, with all my software and smarts <?:namespace prefix = v ns = "urn:schemas-microsoft-com:vml" />), but I don't believe that past performance (by any metric; sharpe ratio, alpha, upside/downside capture ratios, style adherence etc...) is predictive of future performance, and I believe that the vast majority of the nobel winning academics you often cite, would agree. 

[/quote]

I think you're wrong about what experts say on that. You've heard that line often about mutual funds (most can’t beat the S&P 500, blah, blah, blah), but let's not forget all the drags on mutual funds aside from the obvious fees and taxes (the in and out at the worst time behavior of owners of funds, for example). Your software will get you a long way, but results alone aren't enough. You have to dig deeper, like attribution reports that explain WHY they did well. Who knows, you might be looking at a manager who got lucky with a single high flier or two and has been dining on that ever since.

[quote=dude]

In fact the vast majority of research on the subject overwhelmingly supports my position, with the exception of more inefficient markets and even then I have never seen an overwhelming majority of emerging markets and small cap funds outperform their indices consistently;  usually it's pretty close to 50/50.  

[/quote]

No, sorry, Dude, but that’s not true. The overwhelming majority of research does not say active management can’t beat indexes (and we’re to a degree mixing apples and oranges, even if you completely agree that passive beats active investing, that doesn’t mean you have to reject asset allocation along styles and cap, it just means you’ll use indexes to do it) and when you’re talking outside the S&P 500 to the other indexes there are plenty of managers who beat them like drums year in and year out.

[quote=dude]

It would seem that the problem would be that someone who follows most allocation models would only put a small portion of the overall portfolio in those asset classes, so any outperformance would have minor effect. 

[/quote]

Well, I can’t speak to “most models”, but I can say I typically only use 45 to 50% in LC and the balance, including 20% plus in international and the out performance is anything but minor.

[quote=dude] I have heard concerning the financial planning approach,

where some people say that their job is not to find managers that beat

their indexes, but to help people meet their financial goals.

[quote=skeedaddy]I appreciate these types of discussions, if for no other reason, because they keep me sharp and informed. As I've said before, Mike, I believe that you do an excellent job of arguing. Just a couple more years of education and you could have been arguing before the Supreme Court. [/quote]<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Thanks, I think. Law school was always out of te question, my parents were married  <?:namespace prefix = v ns = "urn:schemas-microsoft-com:vml" />

[quote=skeedaddy]

 So don't take this as a personal attack. Remember, we're professionals.

[/quote]

Hmmm, where's that kevlar and flak jacket I had around here....

[quote=skeedaddy]I had a chance to look into this debate of growth vs. value and came up with some additional information that might be useful. Since 1980, the correlation between Russell 1000 Value and Russell 1000 Growth is .82.

[/quote]

That's a pretty striking divergence between categories of the same cap. Furthermore, as I'm sure you're aware, that 25 year time horizon does a great job of masking the many rotations where divergence was far, far greater. It's not much different than the long term studies (think the classic Ibottson mountain chart that shows the lines so smoothly assending and the results so similar between cap classes) that minimize differences.

[quote=skeedaddy]

that In 100 quarterly observations, they have moved in opposite directions only 5 times or 5% of the time.

[/quote]

We wouldn’t expect them to move in opposite directions very often, they’re far too similar. What is key is how far apart they are at times, even if they’re both positive or negative.

An example, in 1998 LCG hit 38.7%, LCV was at 15.68. Your 25 year time horizon may swallow up that massive difference, clients won’t. Better still, rebalancing, which isn’t present in your figures accelerates that advantage of being in both categories instead of one.

BTW, as a further example, back to 1998, SMV was at   -6.43%, SCG was at 1.24% and EAFE was at 20.34%. With rebalancing you wouldn’t have allowed that LCG to run wild after 1998 and would have ensured that some money returned to SMV (instead of allowing it to shrink more and more) so that you would have had a reasonable foothold in it in 2000 when it returned to 22.8% and your formerly high-flying LCG 22.43%.

 There's where money was saved and made.

[quote=skeedaddy]

 Since 1979, the average annual difference in returns between both styles has been only 2.2%.   So all this time we've been splitting hairs on 200 basis points difference.

[/quote]

It’s only 2.2% if you ignore every other cap and style and look over the long, long horizon.

Then again, if you measured the height of only white males, age 35,  living in <?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Minnesota during a 25 year period between 1979 to today, you’d find, I’m guessing, a much smaller divergence than if you measured the height of all males round the world since time began.

[quote=skeedaddy]

Laurence Siegel is the guy who manages $10 billion for the Ford Foundation, who has better information and better portfolio management capabilities than you or me, hasn't been able to devise a trigger system to exploite a change in leadership.

[/quote]

I don’t know anyone who HAS found a way to exploit leadership changes. That would require a predictive ability to determine which cap and style was going to be in favor next (gee, sounds like stock picking).

Then again, that’s not what we’re trying to do. We’re trying to maximize return on each unit of risk taken. You can be pretty certain that Laurance, like every other manager of large endowments and foundations I’ve ever heard of, pays very close attention to cap and style diversification and doesn’t have one manager running every dollar he has.

[quote=skeedaddy]

I do agree that diversification is important, it just doesn't exist amongst US equities. .82 correlation is not diversification to me.

[/quote]

Fair enough (although .82 is a remarkable variation given the timeframe and the similarities of the two LC categories). Then again, just looking at LCG and LCV isn’t the entirety of US equities.

[quote=skeedaddy]I'm curious does Warren have any investments in India or China?

[/quote]

I couldn’t tell you, since the only way to hire Warren is via BRK, I don’t follow his holdings in detail.

However, I can tell you two things, India and China alone aren’t a reasonable representation of the totality of international markets AND there are managers using Warren’s Graham and Dodd bible that are buying in international markets.

[quote=skeedaddy] [quote=dude] I have heard concerning the financial planning approach, where some people say that their job is not to find managers that beat their indexes, but to help people meet their financial goals. 

[/quote]

That's a ridiculous position to take. I'm curious, does the CPI include
prescription drugs into the calculation? I know they don't include energy and food.

[/quote]

The topline CPI does take food and energy into consideration, you may be thinking of the core number, which doesn't. That's why the core rate is only used to look at ultra-short time periods where the swings in fod and energy would otherwise distort the numbers).

Mike,

My concept of the retainer fee is that there would be a one time up front fee of say $1,000 (specifics not important here) for the initial planning work and an on going annual flat fee based on services provided (like on call financial advice, education, plan updating etc... ) and time expected to work on the project.  Like how a lawyer is paid.

Now I'm not preaching this as an end all be all, only right way, dogma.  I'm merely trying to open some discussion about how to best price our services.

Mike it seems like you and I agree on more areas than we disagree when it comes to compensation guidelines.  You have to agree though that the vast majority of advisors using asset allocation are doing just as I described: Ibbotsson Strategic allocation model (or something very close), 5 risk profiles, static allocation with annual or quarterly rebalancing. 

I still don't know if I agree with you that past performance metrics (including attribution analysis) will be predictive of future results for a particular manager.  I think that there are some fundamental errors to the ways academics carve up the investment markets (value vs. growth, volatility = risk, etc....).  It is my belief that quantifying anything that is the direct result of millions (if not billions) of inputs having their basis in human emotion is akin to hearding cats, or at least coming up with mathmatical equations to describe the various dynamics of hearding cats. 

[quote=dude]

Like how a lawyer is paid.

[/quote]

Be careful what you wish for.  I have many lawyer friends, and they would all tell you that their system of compensation is what they hate most about being a lawyer. 

And they will also tell you that the highest paid attorneys are those working on a contingency fee.  The contingency fee being the closest thing they have to our system of compensation.

You guys are starting to make my head hurt…

A lot of lawyers like being paid by the hour. It’s not bad, since they’re allowed to bill out 71 hours per day.

joedabrkr said:

Be careful what you wish for.  I have many lawyer friends, and they would all tell you that their system of compensation is what they hate most about being a lawyer. 

Reply:

I'm not wishing for this, just hoping to have a discussion on the various compensation models and what should be the most appropriate approach given the services provided.

As for your head hurting; at least this is a productive thread as compared to the Jones Rumble Royal next door.  That place gives me a migrane. 

[quote=dude]

Mike,

My concept of the retainer fee is that there would be a one time up front fee of say $1,000 (specifics not important here) for the initial planning work

[/quote]

I'm not sure about every wirehouse, but I know of two that do offer a topline, non-boilerplate paln in this price range. I doubt they sell many.

[quote=dude]

and an on going annual flat fee based on services provided (like on call financial advice, education, plan updating etc... ) and time expected to work on the project. 

[/quote]

This part, given the compliance issues involved, might not be something wirehouse would want to do.

[quote=skeedaddy]
....I do agree that diversification is important, it just doesn't exist amongst US equities. .82 correlation is not diversification to me.
[/quote]

Interestingly, this month's IA magazine has a story, "Boxes are not Classes" which is directly on point to this misconception regarding portfolio composition.   At the end, they say that stocks are stocks and is one asset class. 

Reasons:

1. US stocks are not compositionally unique. Wilshire, S&P, Russell categorize the same stocks differently.

2.  Unstable membership. At S&P, one in every nine stocks change categories. 

3. High correlations (avg. .80) equals low diversification. 

[quote=skeedaddy] [quote=skeedaddy]
....I do agree that diversification is important, it just doesn't exist amongst US equities. .82 correlation is not diversification to me.
[/quote] <?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Interestingly, this month's IA magazine has a story, "Boxes are not Classes" which is directly on point to this misconception regarding portfolio composition.   At the end, they say that stocks are stocks and is one asset class. 

[/quote]

http://www.investmentadvisor.com/issues/2006_1/features/5853 -1.html

There's the link so others can review it for themselves. Note the author's agendas, more about their company below.

BTW, didn’t we dismiss the “.82” figure as irrelevant since you limited your comparison to LCV and LCG and over a 26 year time horizon?

[quote=skeedaddy2]

Reasons:

1. <?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />US stocks are not compositionally unique. Wilshire, S&P, Russell categorize the same stocks differently.

[/quote]

Weak. Just because various agencies disagree about exactly definitions doesn't mean there's not a real difference between categories. That’s like saying there’s no real difference between EAFE/emerging markets and the US market since EAFE and emerging market indexes hold differing names.

[quote=skeedaddy2]

2.  Unstable membership. At S&P, one in every nine stocks change categories. 

[/quote]

Huh? Just because by one agency's definition 11% move from one category to another means there's no difference? That means 89% DON’T move. Personally I found it rather surprising that that number wasn't higher with SC moving to MC, MC to LC. The question isn't does some small percentage move, it's what do they act like while they're in a given category.

[quote=skeedaddy2]

3. High correlations (avg. .80) equals low diversification. 

[/quote]

The high correlations only appear on longer time horizons when the twist, turns and the variations disappear. Those correlations year to year are much, much lower (again, example, 1998 when LGV was +38.70% and SCV was at -6.43%) and it’s those disparities that rebalancing takes advantage of.

Furthermore, the correlation between small and large cap run in the .6 to .7 range and the authors managed to somehow completely exclude the examples of the correlations between emerging markets and EAFE from the US equities they discussed.

 http://www.athenainvest.com/index.cfm?action=home

More from the same authors. I remain unconvinced.

[quote=dude]

joedabrkr said:

Be careful what you wish for.  I have many lawyer friends, and they would all tell you that their system of compensation is what they hate most about being a lawyer. 

Reply:

I'm not wishing for this, just hoping to have a discussion on the various compensation models and what should be the most appropriate approach given the services provided.

As for your head hurting; at least this is a productive thread as compared to the Jones Rumble Royal next door.  That place gives me a migrane. 

[/quote]

I didn't say that.....