Simple Performance Lessons You Have Not Learned - Challenge The Status Quo
Wednesday, May 30, 2012 15:54

Tags: active management | benchmarking | Due Diligence

Half of the active managers should beat their benchmark, yet evidence suggests they do not. That is, evidence contradicts Dr. William F. Sharpe’s acclaimed “Arithmetic of Active Management,” which predicts that managers collectively will earn the benchmark return, with half exceeding it and half trailing it. Clients want performance but they are not even getting a 50-50 shot at it, due in large part to the inability of many advisors to identify skill. That’s because many of you are measuring performance with a ruler – the wrong instrument.

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The CFA Institute’s Benchmark Committee issued a report in 1998 that recited a litany of problems with peer groups and advised against using them. However, the institute conceded that most readers were likely to ignore the warning. The report goes on to recommend custom benchmarks. This report has been removed from the institute’s website, but I’d be happy to send it to you.
I agree with the report in large part, and I have created the glue that holds custom benchmarks together with a replacement for peer groups. If you rely on benchmarks (custom or otherwise) you'll find that you need to wait many decades to get a significant alpha, even if the manager is reasonably skillful. The "glue" is to instead view performance evaluation as a hypothesis test. We test the hypothesis “performance is good” by simulating all of the portfolios the manager could have held, selecting stocks from the custom benchmark, to create a custom peer group. This gets rid of all the biases in peer groups and solves the waiting problem with custom benchmarks.

A related issue is the creation of custom benchmarks. In his seminal article that introduced style analysis, Sharpe said the style palette should comprise indexes that are mutually exclusive and exhaustive. Russell, MSCI and S&P indexes do not meet these criteria. Plus Russell indexes have two other problems: annual rebalancing and the reliance on Price/Book. The book values of fallen financials in this economic crisis are grossly overstated.
There are two index families that do meet the Sharpe criteria, Surz and Morningstar. Morningstar copied Surz.

The three key due diligence questions are:
What does this manager do?
Does he do it well?

The third question is attribution, and is the most forward-looking. To get an accurate answer you need a holdings-based system that provides an accurate benchmark, because if the benchmark is wrong all of the analytics are wrong. There are only a few attribution systems that allow custom benchmarks, such as FactSet and StokTrib. Most attribution systems are limited to off-the-shelf indexes as benchmarks, which only work for index huggers.

So these are some of the better methods. More details are available at and These contemporary improvements have not become mainstream because some, albeit a minority, benefit from the status quo – theyprefer to see due diligence remain in the Dark Ages. Are you happy with the status quo? If not, what are you waiting for?

Client Spending Habits Are The Focus Of A New Schwab Video Series
Wednesday, May 30, 2012 10:00

Tags: client education | communication | investment strategies | investor behavior

Spending rates of clients has become a focus of a new video series created by Charles Schwab. The firm has set up an open access site that invites the public to share their experiences about their spending habits. Out-of-control spending habits can dissipate wealth even in the hundreds of millions faster than investors realize. They can wreak havoc on the most strategically, well-thought-out investment plan.

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Making it fun to talk about such serious topics can add comfort to the discussion while driving home essential principles.
In the Schwab example, a vote will be held to decide which stories are favorites and Schwab will run a contest between May 29 and June 26 where the ultimate winner will be awarded a prize of $10,000—deposited into a Schwab account, of course. Are there ways you can think of that would make difficult topics easier to approach and ultimately help to keep your clients from sabotaging their own success?

A European Banking Union May Calm Worries Of The Eurozone's Demise
Wednesday, May 30, 2012 09:49

Tags: economy | global investing | markets | U.S. economy

Instead of a few banks bearing the burdens of rescuing troubled debtor countries in the Eurozone, creating a bank union to more broadly absorb the risks is the recommendation of the European Union’s executive arm. This echoes recommendations coming out of a Marcus Evans global conference currently going on in Montreux, Switzerland.

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The cost of borrowing for distressed countries escalates as confidence erodes in the ability of those countries to pay back the debt. The need for some type of risk sharing mechanism and a synchronization of the business cycle accompany recommendations for encouraging capital mobility and labor market flexibility.
Sharing the burden across a broader number of banks would also lessen investor fears of investing in any one country. Solidarity could be built so that needed investment dollars would flow more freely, especially to those countries who need it so desperately. The worries of one country can easily spill over and threaten others. And the rescue ability of strong countries can be compromised if they are the only source for financial assistance.
The European view of the US economy is a positive one, noting that the US has done a good job of managing its financial and economic woes despite the fact that the recovery is still not on solid ground.


New State 529 Plan Options Can Be Great Ice Breakers For Client Conversations
Wednesday, May 30, 2012 09:15

Tags: client education | 529 | communication | marketing

It’s astounding. A recent survey by Edward Jones reveals that 62% of respondents thought a 529 plan was some type of insurance or a retirement plan. Not only does that indicate that investors are missing the benefits of owning a 529, it also means that they are likely unaware of recent changes that would impact the way they use the plans.

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Because families who do own them have become more sensitive to market volatility, many states are adding different investment options such as certificates of deposit. The 529 plans may offer a better rate on a CD than an individual can normally negotiate but investors should also be aware that expenses of added programs to the plans can eat into their money market returns.
These additions include investment options run by external managers. Although more choices may sound good, investors should realize that they can only change their allocations once a year unless they change beneficiaries to the plan. The more options in a 529 program, the more expenses can detract from the benefits. As with many other formerly simple investment plans, 529s now require a more strategic look to take advantage of their benefits. What a great topic for contacting your clients and expanding your network!

Watching Europe's Economic Indicators Can Clue You In To Global Economic Impact
Wednesday, May 30, 2012 08:31

Tags: economy | European zone | global investing

In a global marketplace, what happens in the rest of the world has a bearing on what happens in the US. US Market action proves this point and news from Europe is still one of the major market movers global investors are watching.


As it has been for the US, the month of May has also not been so merry for the Eurozone countries. Confidence in business growth ebbed in step with worsening fears that, for the first time, a Eurozone country might leave the union. Italy and the Netherlands led the drop in sentiment. The European Commission’s confidence indicator slid from 92.9 in April to 90.6. Estimates had targeted a much milder drop to 92.

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Confidence levels in France, Germany, and ironically, Spain experienced milder declines. The good news is that inflation is also on the decline. This raises hopes that the European Central Bank (ECB) will be more inclined to introduce new stimulus actions designed to add growth to counter balance its traditionally singular austerity focus.
Banks are also beginning to ease credit availability. Wide availability of three-year loans to businesses and to Europe’s private sector are seeping into the broader economy. Easier credit has not helped the manufacturing sector, however, and the European Commission’s manufacturing confidence measure dropped to negative double digits (-11.3) from negative nine. Consumer confidence is the bright point here as consumers registered a more positive outlook for job growth and economic improvement. Italy and Spain were the exceptions here.


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