ITA Wealth Management readers who appreciate past recommendations of Karl Jenkins compositions will certainly enjoy Stabat Mater.  The third, (Vidit Jesum in Tormentis) and fourth (Lament) cuts are particularly beautiful.

Photograph: The Pleiades Cluster – a young galactic cluster containing about 100 stars, formed 60 million years ago.  Each of the hottest stars in the cluster is surrounded by the blue glow of its own light reflected from the surrounding interstellar dust.

Here is hoping football fans enjoy a good game.  I’ll be watching.

Early in January I encouraged investors to set out on a new path of investing.  Let’s run through a checklist to see how well you are doing.

Investment Checklist

1.  Portfolio Policy:  Have you written up a portfolio plan or put it into a spreadsheet format?

2.  Saving:  What is the plan to save on a regular basis?  Portfolio planning us useless unless one is saving to build a portfolio.  Remember the first chapter of Ellis and Malkiel’s book, “The Elements of Investing” and how it recommended a savings plan?

3.  Books:  What is the education plan?  What books are you finding useful?  Make recommendations for other readers of this blog.

4.  Asset Classes:  What asset classes are included in the portfolio plan?  Is the portfolio sufficiently diversified?

5.  Percentage Allocations:  What percentage is allocated to each asset class?  Are you finding examples on this blog of use.  If not, how can I help?

6.  Risk:  Is a sample portfolio available so one can upload it to the RiskGrades site and check out if the risk level is acceptable.

7.  Monitoring:  What means are in place to monitor the portfolio to see if it is carrying out the Portfolio Policy?

Investing requires discipline and the above seven (7) checklist items are to help investors gain traction as they build a portfolio.

Photograph:  Spring is here when this cat shows up at our back door.  We have yet to see her this year.

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Continue to keep an eye on the Information Ratio (IR) as that value provides a clue as to how well the portfolio is performing with respect to the portfolio risk.

Portfolio Performance: 5 February 2010

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Portfolios tracked by Captool are updated as of 1/29/2010.  A few portfolios tracked using the TLH spreadsheet are current as of 2/4/2010 and more will be updated early next week.  Recent market movements dealt a harsh blow to a number of the portfolios, but overall, they continue to do well vs. the VTSMX and ITA Index benchmarks.  Limit orders were struck during the recent downturn and I need to enter those transactions into the TLH spreadsheets I use to monitor the portfolios.  More data is provided to Premium subscribers.

Readers new to the blog should search “customized benchmark” or “ITA Index” to find out more about how this benchmark is use to monitor portfolios with specific Portfolio Policies.

Portfolio Performance: 4 February 2010

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In my files, I have a paper titled, “A Comparison of Active and Passive Investment Strategies.” I don’t know the origin of this paper as there is no reference given. I think it was prepared for an investment committee that was in the process of making a decision whether or not to move away from active management and toward a passive investment strategy.

Which Works Best – Active Management or Passive Management?

“Research supporting passive management comes from the nation’s universities and privately funded research centers, not from Wall Street firms, powerful banks, insurance companies, active managers, and other groups with a vested interest in the huge profits available from active management.” We might add CNBC, other financial broadcasts, and financial newsletters into the mix as they are vitally interested in active management.  Investors would be better off if they followed the research rather than the advertising money.

“The results from this research are very clear: Active investment management is an appealing mirage which substantially boosts costs and decreases returns compared to properly designed passive portfolios.”

When we speak of passive and active management, definitions are necessary.  Active management is much easier to define as it is the art and “science” of security selection based on a belief that a manager can consistently predict financial events better than other managers, and as a result, outperform the broad market or a particular benchmark. There is abundant research to show this is a myth.

Passive management is not as easy to define.  The passive management style carries multiple definitions or at least the term is used loosely.  I suspect I’ve fallen into this trap as well over the nearly two years I’ve been writing this blog.  If we define passive investing narrowly, at the very least, it is the antithesis of active management.  That much is clear.  The passive manager recognizes they are unable, through research, brains, clever moves, instinct, and investment software, to outperform their benchmark.  The passive manager recognizes that net of costs, they are unable to “beat the market,” but they can perform better than the majority of active managers.

The passive manager will lay out an investment policy of several asset classes and then populate those asset classes with index funds so as to mirror the policy.  Market timing is out of the question.  Tactical Asset Allocation (TAA) is on the no-no list.  Rebalancing is permitted.

I do not claim to be a pure passive investor.  While I certainly tilt toward passive investing when compared to active investing, I do tilt portfolios toward value vs. growth and toward mid and small-cap size vs. large-cap size. Those moves could be considered active decisions.  In addition, I will sprinkle in an individual stock in larger portfolios.  These are moves a pure passive investor would not do.  The reasons for making these “active” management decisions is to add alpha to the portfolios.  There is research to back these moves and it has paid off over the past 10 to 12 years of detailed record keeping.

I prefer to call the investment style used here at ITA Wealth Management a Mosaic style.  The primary “flavor” is passive with a little “seasoning” of active added in order to enhance the “taste” — that of performing better than the benchmark.

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It is difficult to name the very best investment book, or the one to read first.  Different investors react differently to different authors. Nevertheless, here are recommendations that will get interested readers off in the right direction.  If you are looking for a concise and simple book, I can think of none better than Charles D. Ellis and Burton G. Malkiel’s tiny book, “The Elements of Investing.”  In this small volume, you will find the very basics of investing.  This is a great book to launch you into my second recommendation, William J. Bernstein’s “The Investor’s Manifesto.” Bernstein is simply one of the best investment writers in the business.

After reading these two “starter” books, you are set to work your way through authors such as Roger Gibson, Larry Swedroe, Richard Ferri, Mark Hebner, John Bogle and more of Bernstein.  Search these name on this blog and you will find all the titles by these excellent authors.

As you build your investment philosophy, think how you are going to structure a Portfolio Policy.  Am I going to build a portfolio through selecting individual stocks or through index investments?  Will I use actively managed mutual funds or index funds?  How will I know if I am on the right track?  Can I do this on my own or do I need professional management?  The authors I recommend will help readers answer these fundamental questions.  No one author will answer all the questions, but as you read author after author, the ideas will slowly become second nature and you will be able to manage your own money.  Start now with the Ellis Malkiel book.  One last bit of advice is to continue reading this blog.

Photograph:  Young girl in Lima, Peru.  I captured this image through the window of our van and was fortunate not to pick up any noticeable reflection.

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I am using the modified asset allocation mix described by Dr. Considine.  The projected annual return is 9.3% and the projected risk comes in under 15%.  Scroll down to the Diversification Matrix and you will see it is only 30%.  Not too bad, but not up to our goal of 40% under current market conditions.

Using these ten ETFs as the standard, we want to see if we can improve on these three metrics.  If I manage to improve on this portfolio, I will post results over on the Premium Content side of ITA Wealth Management. 

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The CD recommended this week is Beethoven’s Piano Concerto No. 5 in E flat, “Emperor” Op. 73 and

Since I missed a recommendation last week, I’ll add a bonus this week.  It is Leo Kottke – Instrumentals.  This guitar music has a different sound, at least it does for me.  I encourage you to listen to some samples to see if you enjoy his music.  I do and that is why I include it as another recommendation.

Photograph: Peruvian art.

In the first screen shot we have eighteen (18) international ETFs covering all major countries in the world.  In the table below, we see the investments and the percentage of funds invested in each.  To sum to 100%, I “invested” 10% in VTSMX which does not show in the following table.  Examine  the data within the blue background.  Note the projected annual return is 11.6% and the projected standard deviation (risk) is 22% when rounded.  While the return is quite good in the current market, the risk is much too high for most investors.  As a general guideline, we prefer to see the SD value below 15%.

Scroll down the page till you see the Diversification Metric (DM) percentage of 15%.  The DM percentage is telling us we do not have a well diversified portfolio.  Even though we are spreading our investments all over the world, this international portfolio falls short of our diversification goal.  DM should top 40%.

Now move down to the second screen shot, or the correlation graph.

In the correlation table below, I did not include all the individual correlations as the table would have spilled off the right-hand edge of your screen.  I only included how the different international ETFs are correlated to the overall portfolio.  Note that only IDX is below 80% and that ETF has a record less than two years so the data is suspect.  This combination of ETFs is not one to build a low correlation portfolio, even though one would think it is well diversified.

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In the data table below, readers will see updated information for a number of portfolios tracked over on the Premium Content side of ITA Wealth Management.  As January broker statements become available,  additional updates will be posted, particularly those portfolios tracked using Captool software.

The IRR column is the Internal Rate of Return for the different portfolios.  ITA Index is a customized benchmark and is only available for users of the TLH spreadsheet.  VTSMX is Vanguard’s Total Stock Market Index Fund and we use it as a broad based benchmark.  IR is the Information Ratio.  For additional definitions of IR, check it out on the Internet or search for it on this blog.

While all IRR values decreased this week, most of the portfolios gained ground on the VTSMX benchmark.  What is most notable is that every updated portfolio performed better than either the ITA Index benchmark or the VTSMX benchmark.  It is highly unlikely this will continue as it is extremely difficult to set up portfolios that will perform better than the total market.

Portfolio Performance: 29 January 2010

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Photograph:  Jungle guide in Peru.