ITA Wealth Management

William Boyce (1711-1779) composed eight symphonies and they all fit on to one CD.  The recommendation this week is his 8 Symphonies on this CD.  These short symphonies are a delight, particularly his first. This Archive production features The English Concert directed by Trevor Pinnock.

While Boyce would not make my top ten composers, I do think this CD is a must for your classical music collection.  The symphonies are light, melodic, and will definitely bring sunshine to a dark day.

Lowell Herr

Photograph: The machinery of a working steam driven tractor.

Regular readers of this blog know I am a strong advocate of asset allocation or spreading your savings over a wide variety of asset classes.  The reason for using asset classes rather than market sectors is that covering all the asset classes automatically covers all sectors, but investing in all eleven market sectors will almost always leave some asset classes without any coverage.

The logic for using asset allocation is to increase the Information Ratio.  In other words, we want to increase the ratio of return/risk.  In two portfolios, covered in detail over on the Premium Content side of the blog, the risk was reduced from 25% down to the 15% level by moving from individual stock selection to using a wide array of ETFs.  This reduction in risk took place during a period when the market was quite volatile.

The approach on this blog, while not completely shunning individual stocks, is to build portfolios using research that comes from Ibbotson & Associates, John Bogle, Fama-French, and William Bernstein.  Stock picking is not central to sound investing as pointed out by Ibbotson.  For readers still committed to stock picking, here is a reference well worth additional examination.  Take time to dig into the many references that take one deeper into the difficulties involved in picking stocks.  Work your way down to Stock Picking Academic Research and read a few of those references. It does take time to be convinced of the importance of asset allocation vs. stock picking.

Of the seven portfolios actively tracked over on Premium, only one portfolio is lagging the VTSMX index, and this portfolio does not have a tilt toward value.  It is my contention, and the portfolios bear this out, over the long-term, one does better if the portfolio is slightly skewed toward the value side of the investing spectrum.  There is an eighth portfolio I report on every few months, and it too is doing much better than the VTSMX benchmark.  Several of these portfolios are truly passive in that very few trades occurred over the last eight to ten years.

The seven portfolios examined on a regular basis are of different size and were launched during different market periods.  Those started in the last two years have miserable absolute records, but their relative records, as measured against a benchmark, are doing quite will with the one exception.

Some of you are aware of a wager I was involved in some years ago.  At least the initial discussions started in 2002.  The debate between two individuals (I was not initially involved.) focused on stock picking and index investing.  One side took the position that it is difficult to perform better than the index so one should invest in something like the S&P 500.  The opposing side argued one could pick individual stocks using a particular software program, and by using this program could double their money in five years.  Rather than argue either position, I posited a wager where I would invest a sum of money and use the software program to manage the stock oriented portfolio.

As you might imagine, there was quite a bit of interest generated in this debate of stock picking and index investing.  It even expanded to the point where the portfolio tracking company, Bivio, developed a benchmarking system to track this portfolio with respect to a standard.  We chose Vanguard’s Total Market Index Fund, VTSMX, to be the benchmark as it was the fund that covered the widest array of stocks.  Another side benefit of this wager was the development of what is known as the Thomas Portfolio Tracking Spreadsheet.  That spreadsheet is now what is known as the T/L/H spreadsheet as it has received some enhancements.

Keep in mind that the original wager was not whether the managed stock portfolio would outperform a benchmark such as the VTSMX, but whether or not it would double in a five-year period.  I figured it was a win-win situation as I would easily be able to pay off the wager if the portfolio doubled in five years.  Oh yes, I took the side that the portfolio would not double in five years.  That seemed almost too good to be true.

The wager ran from 10/31/2003 through 10/31/2008 as the portfolio was not fully invested until 10/31/2003.  Did the portfolio double over this five-year period?  Not even close, and as you will recall, during that five-year period we had a rather respectable market.  Moments ago I checked the results to see how well the managed stock portfolio performed vs. the VTSMX index from 10/31/2003 through 3/27/2009.  I see where the ICLWager or managed stock portfolio turned in an annualized 1.8% return while the VTSMX lagged at negative 2.4% (-2.4%).  That is a significant difference of 4.2% in favor of the stock picking software program.  This is one reason why we do not completely avoid adding some stocks to the portfolio.

Lowell Herr

Photograph: Steam powered tractor.

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Do you fall into the hedgehog or fox style of thinking, and how does it impact your investing methods? (The fox knows many things, but the hedgehog knows one big thing.”)  Think about this for a moment before answering.

Maybe we are all a little bit of both, but lean more to one side than the other in our thinking processes.  As a Mosaic Investor, I like to think of myself as a “fox thinker,” but due to an obstinate nature, particularly when it comes to facts, — well, I might be tugged over to the hedgehog side of the thinking spectrum on occasion.

A “hedgehog investor” is one who knows a method of investing (a big idea) and will stick with it regardless of any evidence suggesting they might be wrong, or at least misinformed.  “Hedgehog investors” are reluctant to break with their “big idea” or examine their methods when questions are raised as to its validity.  In many cases, it is the lack of evidence supporting the investing method that should raise the flag of warning.

Let’s use an example I followed back in the 1970s and into the 1980s.  To my knowledge, this investing method is no longer used so no harm should come to any readers.  This timing model was followed by so many investors at the time that a signal to move in or out of the market actually had an impact on the market.

The timing model used no-load mutual funds that permitted one to trade over the telephone.  Remember, no Internet was available to T.C. PITS at the time.  Here were the trading signals.  When one was out of the market, you were to remain on the sidelines until the 200-Day Moving Averages for both the NYSE (It might have been the DJI) and the Dow Jones Transportation averages moved from below to above the moving average.  When both averages were positive, one moved all cash into the no-load mutual funds of choice.  The service also included mutual fund recommendations.  The investor stayed in the market until both the NYSE and DJT averages moved from above to below their 200-Day Moving Averages.  These were not Exponential Moving Averages, but simple moving averages.  Even though the trading rules were clearly explained, if one did not want to do this on their own, we were welcome to turn our money over to this advisor at a cost of 3% of the portfolio value.  I considered a 3% fee for this service to be usury.

Please note – I am not an advocate of the above timing model.

Here we have a “big idea” or a hedgehog approach to investing.  Now if one applied a little “fox thinking” one could outsmart this well known investment advice by using Exponential Moving Averages (EMAs) instead of Simple Moving Averages (SMAs).  Remember, EMAs are faster moving averages compared to SMAs.  Using EMAs one would exit and enter the market a few days before the timing advisor gave his buy or sell signal, thereby avoiding the market move when this “hedgehog advisor” gave his signal.  On one occasion, this advanced warning resulted in avoiding a 22% single day drop in the market.  Anyone remember “Black Monday” back in October of 1987?

Without getting too specific, there are still “hedgehog thinkers” working the marketing system without providing evidence their investment advice actually works, and by works, one generally means the investing method will perform better than a benchmark.  The S&P 500 is one of the most used equities benchmarks in this country so one expects a portfolio will outshine the S&P 500.

A “fox investor” is constantly taking in new information, particularly research that breaks new ground.  This investor also has a reliable method for determining portfolio performance and portfolio risk.  These two important measuring instruments are wrapped into one important ratio — the Information Ratio.  It is unfortunate this ratio does not carry a more descriptive name, but we will go with the common usage.

Perhaps it is a bit of the “hedgehog” in me, but I think asset allocation (AA) is really a “fox” or even “foxy” approach to investing.  Combine AA with some technical analysis, tactical asset allocating, mix in QPP analysis and one begins to put together an investing model that can be shown to reduce risk while improving performance.  And that is what it is all about.

Lowell Herr

Photograph: Tulip field near Woodburn, OR

Premium subscription available for $5.00 per month through December 31, 2009.  We make an effort to be “foxy investors” while hanging on to some “hedgehog” investing ideas.