Tax Loss Harvesting And Bonds
Friday, November 22, 2013 02:02

Tags: asset management | bonds | interest rates | investment management | Tax-efficient investing

There's a lot written about tax loss harvesting (TLH) including some articles written by me. I will try to avoid repeating what we all know. After all, although some argue that TLH is not worth pursuing, most advisors agree that accelerating tax benefits is a good idea. 

While true that rebalancing software allows for more frequent, opportunistic TLH, the tech savvy advisors will be joined by the "spreadsheet brigade" in grabbing tax losses at the end of the year. This year, TLH is more important than ever because of the new surtax on investment income. Also, the process can be conveniently used to reposition clients' portfolios. 

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Advisors and clients are both concerned about bond investments. When interest rates rise, bond values will decline. As this rate increase nears (and we get closer every day), shorter term bonds will fall less than long term bonds. And, maturing bonds may be reinvested in higher yielding bonds. 
So, for advisors that want to shorten bond durations (or move to more aggressive bonds), year-end is ideal. Since many of our clients' bond positions have unrealized losses, selling to recognize these losses will provide the opportunity to reposition holdings. 
Please don't ignore this opportunity! In one simple step, you can lower your clients' tax bills, avoid the Medicare surtax and strategically reposition models. Such a deal!
Forget Smart Betas: Step Up to Smarter Betas
Friday, November 08, 2013 19:44

Tags: alpha | indexing | smart beta

Smart betas might succeed in beating the market, but so might smarter betas also, plus smarter betas complete active managers.

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Kudos to Rob Arnott for coining the phrase “Smart Beta.” Everyone wants to be smart. Indexes that use fundamental weightings, rather than capitalization weightings, are deemed to be smart by Mr. Arnott because they are predicted to perform better. For the first time ever, we have indexes that are designed to outperform. All other indexes are designed to match the performance of an entire market or a market segment.
Fundamental (smart beta) weights typically tilt toward value and smaller companies relative to their cap-weighted counterpart, and this tilt has a track record of performing better, so it may indeed be smart. Fundamental indexes are usually created for broad markets, like the U.S. or Europe and have attracted several hundred billion dollars in last few years.
Even Smarter Betas
Because smart beta indexes cover entire markets, they are not intended to be used in conjunction with active managers. If smart beta indexes were used in conjunction with active managers they would dilute active manager decisions by adding stocks active managers don’t want to hold. Furthermore, they would tilt the entire portfolio toward smaller company value, potentially undermining portfolio structure, especially growth allocations.
 Complementing active managers requires an even smarter beta, an index that works best in core-satellite portfolio structures. This smarter beta works better than smart beta, which in turn works better than standard cap-weighted indexes like the S&P500:
Smarter Beta is smarter than Smart Beta is smarter than the S&P500
The smarter beta index is created by identifying the stocks that lie in between value and growth – the stuff in the middle – and by allocating to them using fundamental weights rather than capitalization. The stocks in the middle are organized into economic sectors like technology and utilities, and assets are allocated to these groups at market weights. This avoids any sector bets. Then within sector groups, each stock receives an equal allocation, which is fundamental weighting.
The result is better diversification and higher returns, which is a promise you should question. Better diversification is achieved by adding stocks that active managers usually don’t hold because they don’t fit value or growth mandates. Higher returns result if you replace an existing core with the smarter beta core because smarter beta core does not dilute active managers. This higher return expectation is based on the belief that the active managers actually add value, which seems right since they wouldn’t be hired if that wasn’t the belief.     
Sometimes a good idea has its limitations. Smart betas don’t belong alongside active managers. Smarter betas are required instead. Or put another way, if your investments are entirely passive, smart betas hold the prospect of doing better than a capitalization-weighted market proxy. But if you use active management, smarter beta is what you need.     

Investors Are Still Chasing Alpha Despite Clear Evidence This Chase Is ‘Brainless’
Friday, November 08, 2013 09:46

Tags: active management | investor behavior | portfolio construction | value investing

Despite the data showing active managers fail to beat their passive index alternatives, investors have not given up on alpha – they still want to beat the market. Many have embraced passive strategies such as smart beta, fundamental indexing, and advantageous factor investing, while others pursue the active strategy known as “Active Share.” My term for each of these strategies is “Brainless Alpha.”


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Brainless Alphas are mechanical approaches to investing, and their appeal is obvious – someone has already done all the thinking so finding alpha is easy!
Dimensional Fund Advisors (DFA) has attracted billions of investment dollars with its factor investing approach, and Research Affiliates (RAFI) has attracted more than $100 billion into its fundamental indexes. Smart beta investing is a tilt toward smaller companies and toward value, primarily because history shows that this tilt would have beaten the market. But history doesn’t necessarily have to repeat itself; smart beta will work until it doesn’t.
The active flavor of Brainless Alpha is also attracting assets. Active Share is the percentage of portfolio holdings that do not match the benchmark’s allocations, and big bets are a necessary condition for alpha. It is mathematically necessary to deviate from the benchmark in order to produce an alpha, but big bets are not a sufficient condition for success because the bets can be wrong.

Brainless Alphas go too far in their simplicity. Beating the market is much more complicated than tilts or big bets. If we really want alpha someone will have to think. For a more detailed analysis of these issues, as well as links to relevant scholarly articles, go to “Searching for Brainless Alpha: The Streetlight Approach.”


Rick Ferri's Presentation About His Study Of Performance Of Actively Managed Fund Portfolios Versus Index-Fund Portfolios Gets Rave Reviews From Advisors
Monday, November 04, 2013 11:07

Rick Ferri's presentation last Friday provided hard evidemce about the supremacy of  all-index fund portfolios versus all-actively managed fund portfolios.

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The comments from advisors were very positive and Ferri is succeeding in an area of the RIA business that provides a clear path to a business model that many advisors can utilize.  By focusing on keeping clients' expenses low while providing the advice, rebalancing, and logistical services investors need, RIAs can create a strong business in their locales.

Here's what attendees saoid about the session:

  • Very Informative
  • Excellent. Would like to hear more from Rick with his research.
  • worthwhile
  • An excellent "under the hood" analysis of index versus active investing taken to a level rarely if ever discussed anywhere else. If today's webinar doesn't convince advisors of the technical long-term wealth accumulation merits of passive - index investing versus active investing - then really nothing ever will!
  • Well done
  • Fascinating in that we are working on a rules-based momentum strategy using ETF's across10 to 12 classes a la Israelson.
  • Awesome. Appreciated the robustness of his work.
  • Excellent webinar. I'd like to hear more from Rick in the future, perhaps on the role of nontraditional investments in a portfolio such as REITs, commodities, hedge funds, etc.
  • Great webinar, it has created a lot of fuel for thought.
  • Good presentation, straightforward, helpful background. Looking forward to seeing the slides for add'l review
  • Excellent presentation my Rick. thank you,
  • Excellent
  • enjoyed hearing his research on the various perspectives using different scenarios for comparison of active vs passive
  • Andy needs to wait until after the PowerPoint slide is shown before asking a poll question that is on that slide.
  • This presentation was very informative for advisors using either active management or passive management. Rick's delivery was very polished and easy to follow. Not overly technical and no jargon thrown in to confuse the listener. Also very plain talking, direct approach to this topic without any hidden agenda, therefore very objective viewpoint.
  • Great presentation!
  • Nice job, but no opportunity for rebuttal. A discussion with an opposing viewpoint would have been more helpful.
  • Very interesting and educational!
  • To me, randomly selecting active funds is pretty worthless because the majority of active funds are closet indexers. I also wonder why he did not do a study of how active funds with strong performance and momentum the past year compare to index funds. His presentation added nothing that hadn't been documented many times in the past.
  • Clearly presented and very interesting points. I appreciate the clarity of the sampling and the many scenarios as well as the follow-up questions.
  • One of my clients read about Rick in the "WSJ" (at least) three or four years ago. The client asked me to interview Rick (I did).
  • I thought it was a good session. Rick confused me at various times during his presentation but I was able to catch up. The pop up surveys for CPE can be disconcerting, you fight the urge to be memorizing dates, returns, etc. in anticipation of getting the question "right".


Odds For Investment Success Worsen When Investors Select Two Or More Actively Managed Funds In An Asset Class
Thursday, October 31, 2013 09:59

Guest post from index fund expert Rick Ferri:  Portfolios holding only actively managed funds have a low probability of outperforming a comparable all-index-fund portfolio. In A Case for Index Fund Portfolios, a whitepaper I co-authored with Alex Benke, CFP© of Betterment, we show that portfolios of actively managed funds have a low probability of outperforming an all-index-fund portfolio.  (On Friday, I am speaking at an Advisors4Advisors webinar about the results of the study.)  
Our research shows that when investors select two or more actively managed funds in an asset class, they reduce the chances of outperforming an all–index fund portfolio.  Figure 1 illustrates the outcome of one scenario in our study. It covers three asset classes over the 16-year period from 1997 to 2012. The benchmark portfolio invested 40% of its assets in the Vanguard Total Bond Market Index (VBMFX), 40% in the Vanguard Total Stock Market Index (VTSMX), and 20% in the Vanguard Total International Stock Index (VGTSX).
Probability of an all-index-fund portfolio outperforming an all-actively-managed fund portfolio.
Figure 1: Probability of an all-index-fund portfolio outperforming an all-actively-managed fund portfolio.   

The three-index-fund portfolio outperformed the one actively managed fund portfolio 82.9% of the time. When two actively managed funds were selected in each of the three asset classes (a total of six funds), the odds in favor of the all-index-fund portfolio increased to 87.1%.  Finally, when three actively managed funds were selected in each asset class (a total of nine funds), the odds reached 91.0% in favor of the all-index-fund portfolio.  


This finding has meaningful implications for mutual fund investors, and should be of particular importance for participants in self-directed employer sponsored retirement plans.  An all-index fund portfolio has a high probability of outperforming actively managed funds. However, if actively managed funds are selected, it’s generally better to pick one fund per asset class and hope for the best.


Past performance does not guarantee of future results. Portfolio Solutions® will make a list of all recommendations within the immediately preceding period of at least one year available upon request.

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