ITA Wealth Management

The AA-Mosaic Portfolio ended the first three months with a negative 9.4% IRR (-9.4%). It is not easy bucking a strong negative market, as shown by the negative VTSMX which ended down 27.5% (-27.5%). These are annualized numbers so they are not quite as bad as they look.

Photograph: The market is as tired as Colter.

Photograph: Taken in the jungle of Peru.

The following article was recommended to me and I wish to pass the reference on to others. The article, “Not All Passively Managed Funds are Created Equal,” was written by Larry Swedroe, author of a book I highly recommend, “What Wall Street Doesn’t Want You To Know.“

Photograph: Backyard - Portland, OR

David F. Swensen, the brains behind Yale’s endowment fund, has written an excellent book, “Unconventional Success: A Fundamental Approach to Personal Investment.” On page 334 [copyright of my copy is 2005] he warns investors of poorly structured ETFs. With all the specialized ETFs hitting the market, one better pay attention to Swensen’s advice. Rydex Global Advisors comes in for criticism for their equal-weighted S&P Index Fund “for the ridiculous charge of 0.40 percent of assets, relative to the Barclays charge of 0.09 percent for the standard market-capitalization-weighted S&P Index Fund.” Equal weighted simply means all stocks in the S&P 500 receive equal weight vs. the normal weighting system where the larger companies receive more weight in the index. Swensen goes on, “Not only do Rydex fund investors pay more than four times a fair price for index management services, but the equal-weighted ETF holders face the possibility of adverse tax consequences from the quarterly rebalancing trades required to maintain equal security weights.”

Rydex Advisors is not the only “fleecing” outfit. Consider PowerShares Capital, where they offer an even more expensive ETF, charging 0.60 percent of assets or 60 basis points. PowerShares employs the same quarterly rebalancing as Rydex. In the prospectus of PowerShares Dynamic Market Portfolio they state, “seeks investment results that correspond generally to the price and yield…of an equity index called the Dynamic Market Intellidex Index.”

Swensen takes off on the ‘Intellidex’ term this way. “Intellidex, presumably a compression of intelligent and index, represents a contradiction in terms. By using what a Morgan Stanley research report calls “rules based quantitative analysis” to evaluate and select securities, PowerShares engages in active management, not in passive index replication. The so-called index construction process ranks companies “based on a variety of criteria including fundamental growth, stock valuation, timeliness and risk factors.” Belying the assertion that the Intellidex constitutes an index, the prospectus clearly describes an active-management process that seeks to buy growing companies at reasonable prices in a timely fashion without undue risk. By dressing the active-management wolf in passive-management sheep’s clothing, PowerShares fools the investing public and sullies the otherwise purely passive character of the ETF arena.”

Compare performance on the Yahoo site by bringing up PWC or PWO. Then compare with the S&P 500. After that, compare PWC and PWO with Vanguard’s blend ETF, VV. Draw your own conclusions.

In the process of constructing the AA-Mosaic Portfolio, we avoid esoteric ETFs and stick with the basic low cost ETFs that are tied to well known indexes.

Here is an example of a low risk portfolio. Note in this case the Mean Variance Optimization (MVO) software is recommending 5% (maximum constraint) be invested in AGG (bonds). The expected return is lower and the risk is lower. Excuse the large graph, but I wanted to make it as readable as possible. It should look find on 19″ to 24″ monitors.

Here is additional material as to how to interpret the graph below.

Photograph: Bats clinging to jungle tree near Port Maldonado, Peru

If you go to either of the previous MVO screens, you will find a data table on the far right. That table includes the fourteen (14) asset classes used to construct the AA-Mosaic Portfolio. The raw data contains 59 months of information for each asset class. Since some of these ETF, representing the different asset classes, did not exist 59 months ago, some of the information is somewhat suspect. The GSG commodities asset classes is the major concern. However, the MVO Plus software “pays more attention” to recent data so each month the results are more representative of what the efficient frontier looks like for this portfolio.

I do place constraints on each asset class, using the lower and upper boundaries. Take VEU as an example. This is the developed countries international asset class. The target for this asset class is 20% with an upper boundary of 26%. The Mean Variance Optimization (MVO) software is telling us to keep this asset class populated at the maximum percentage. With this guidance, if the VEU ETF exceeds the upper boundary of 26%, I am not going to be quick to rebalance this asset class.

Note the two asset classes AGG (bonds) and VBK (small-cap growth). MVO is telling us to avoid these two asset classes, at least for the return setting (big red dot on graph) I established for this portfolio. If I were to move that red dot to the left and down the efficient frontier, then I begin to see a recommendation for adding bonds. What is happening is that as I move the red dot to the left, risk is reduced and to reduce risk, I purchase some bonds for the portfolio.

Examine VUG (Large-Cap Growth), VB (Small-Cap Blend), and VV (Large-Cap Blend). In these cases, MVO is recommending holding the minimum percentage in each asset class. In other words, MVO is pushing a recommendation that is at the lower limits of the constraints I established for these three asset class. This is true for other asset classes as well. The three are used as an example. In each case, I would be reluctant to add additional resources to any of them even though they might be below target. This gives an idea how I use the Mean Variance Optimization (MVO) software.

Lowell

I expect this screen will be more difficult to read.  Let me know if you prefer the large screen size or a smaller version.

Physlab

This is a rather large screen capture of the MVO data through March 28.  I will post a smaller image for readers with a smaller screen.

Photograph: Typical apartment in Lhasa, Tibet

Rebalancing a portfolio is a long-term policy for the careful investor.

• One first needs a portfolio policy. This requires the following.

• Establish all asset classes. We are using 14 asset classes for the AA-Mosaic Portfolio.
• Set target percentages for each asset.

• Determine what the upper and lower limits are for each asset class. With the AA-Mosaic Portfolio, we use 30% of the target percentage.
• Rebalance approximately once per year.
• When an asset class grows above the target area on the high side, sell shares of the ETF and purchase ETFs in asset classes that may be below 30% of the target. If none are this low, purchase shares in asset classes that are the greatest percentage below target.
• When possible, rebalance using cash dividends and/or infusion of new cash.
• Keep commission expenses as low as possible.

If soothing guitar music with a Caribbean flavor is to your liking, then Govi’s “Andalusian Nights” is a must CD to add to your collection.

Thanks to all of you who have taken a little time to peruse this Blog. Today ‘Wealth Management‘ will top eleven thousand hits. We appreciate your interest and we welcome comments and questions. Thanks again for your interest.

I trust the photographs add an additional touch of interest.

Lowell