Advisor Blog

Ron Lieber, the New York Times "Your Money" columnist and editor of its "Bucks" blog has written another good article that discusses our investment philosophy.  In Lieber's column, he discusses the "Larry Portfolio", which he has named after Larry Swedroe.  If  you're a regular reader, you know that we think highly of Swedroe's research and his publications and have recently recommended reading his latest book, The Quest For Alpha.  His portfolio design and investment philosophy are based on the same principles and research that we employ.

Lieber's column states that "the point of any long-term portfolio for the vast majority of investors is to earn whatever return you need to meet your goals while taking the least amount of risk."  It goes on to point out that "between 1970 and 2010, small-cap value stocks outearned the S&P 500 by roughly four percentage points annually", referring to the small-cap value research done by Eugene Fama and Ken French.  "For illustration purposes, he points people to the S&P 500 index, which returned about 10 percent annually between 1970 and 2010.  If you wanted to gin up a portfolio to match closely (at 9.8 percent) that performance with much less risk, all you would have needed to do was put 32 percent of your money in a fund mimicking the United States stock index of small and value companies that Mr. Fama and Mr. French developed.  Then you'd put the other 68 percent of your money in one-year Treasury bills".

If you've paid attention to our investment philosophy, you'll recognize this - a tilt toward small-cap and value stocks with risk controlled by adding high credit quality short-duration fixed income in various proportions depending upon a client's risk capacity.

Lieber also points out important caveats about this investment philosophy.  For example, it won't track the indices that most people are familiar with, like the Dow, NASDAQ, or S&P 500.  "You have to tell yourself that you are not going to have portfolio envy or listen to what Jim Cramer is saying on CNBC.  Are you willing to pay that price?"  If you are, you might "see years like 2001 when the Fama/French index gained 40.6 percent while the S&P 500 lost 11.9 percent".  Mr. Lieber also discusses how "education is the armor that protects you from emotions" and the importance of "hiring an educator - an investment advisor - who protects you from the hair-trigger impulses that position your fingers over the sell button."

Unfortunately there aren't many responsible financial journalists.  Most try to sell newspapers and magazines with dubious research (Ten stocks/mutual funds to buy now!) or sensational headlines (Financial Armageddon!).  Fortunately, there are a few that provide a balanced and reasonable point of view. 

Debt crises, sovereign risks, double dips and banking strains: Page One headlines can make for depressing reading these days. But being a smart news consumer—and smart investor—means keeping an eye on the lesser headlines. Here are seven you may not have seen:

• Robust Growth in Germany Pushes Prices—Analysts see a strong chance that German inflation will head towards 3 per cent by the end of the year against a backdrop of robust growth in Europe's biggest economy. (Reuters, July, 27, 2011)

• Brazil Domestic Demand Still Strong—The Economist Intelligence Unit says economic growth in Brazil surprisingly picked up speed in the first quarter, challenging the government’s efforts to cool the expansion. (EIU, July 6, 2011)

• Japan Retail Sales Top Estimates—Japan's retail sales rose 1.1 per cent in June, exceeding all economists' forecasts and adding to signs the economy is bouncing back from an initial post-disaster plunge. (Bloomberg, July 28, 2011)

• No Fear in China—Traders betting on gains in China's biggest companies are pushing options prices to the most bullish level in two years. The Chinese economy is projected to grow by 9.4 per cent in 2011. (Bloomberg, July 28, 2011)

• Southeast Asia Booms—Southeast Asian markets are the world's top performers in 2011 thanks to strong economic and corporate fundamentals. Thailand's index hit a 15-year high in July and Indonesia's a record high. (Reuters, July 22, 2011)

• Australian Boom Keeps Rate Rise on the Agenda—The Australian dollar hit its highest level in 30 years in late July as traders looked to the prospect of another rise in interest rates on the back of a resource investment boom. (WSJ, July 27, 2011)

• NZ Bounces Back—The New Zealand economy has grown more strongly than expected after the Christchurch earthquake, helped by improving terms of trade. The Reserve Bank signals it may raise interest rates soon. (Bloomberg, July 28, 2011)

Standing back from all this, the picture that emerges of the world outside North America and southern Europe is of robust economic conditions. If anything, policymakers in many parts of the world, particularly in Asia, are seeking to pull back demand, rather than stoke it.

Australia, for instance, is enjoying its best terms of trade in more than 50 years. An unprecedented investment boom in mining is injecting extraordinary wealth into the economy and has helped to push the Australian dollar to levels not seen since it was floated in the early 1980s.

Likewise, China, India and much of South-East Asia are seeing strong investment flows and worrying more about over-heating than anything.

This is not to say that all is right with the world. The aftermath of the global financial crisis has created severe problems, particularly in terms of public sector debt and deficits. But we know that that news is in the price. Meanwhile, economic activity in much of the world is thriving.

For equity investors, that means opportunities for wealth building are increasing, not decreasing. Moreover, the global economy is becoming multi-polar, rather than overly dependent on the US, which means the potential benefits from broad diversification are even greater.

That's why focusing too much on the day-to-day headlines with the US debt ceiling or European sovereign issues risks missing many of the good stories out there.

Sometimes, the best advice is to read the newspaper from the inside out.

According to the headlines, "Dr. Doom" - Nouriel Roubini, is predicting another disaster for the global economy.  Roubini became famous after making a prediction in 2006 that there would be a catastrophic global financial meltdown.  After the events of 2007-2009, he made a lot more predictions - but none that have proven to be correct.  Our friend, Eric Tyson, deconstructs the Roubini myth here.

This week, I noticed a slew of headlines about Roubini's latest prediction of another looming disaster.  But, what's most interesting about this is what the headlines seem to imply versus what he actually said.  Every news article focused exclusively on the "perfect storm" that's surely headed our way:

• Nouriel Roubini says "perfect storm" may threaten global economy - The Washington Post
• It's more than a "soft patch", says Roubini - Business Times (Singapore)
• Dr. Doom predicts 2013 gloom - New Zealand Herald
• Roubini's crystal ball forecasts... much more doom! - Barron's
• Outlook for global economy bad or worse says Dr. Doom - Straits Times (Singapore)
• Roubini sees risks fiscal woes will converge in '13 - Boston Globe

But, that was only one scenario that he proposed.  There were
 two others - "anemic, but OK" growth and an optimistic scenario in which the economic expansion improves.  In other words, things will either get worse, stay about the same, or get better.  I'm fairly sure that he'll be right this time. 

There are a couple of important points to be made here.  First, the press loves to create shocking headlines that will sell newspapers or magazines or that will convince you to tune in to their news channel.  They are often taken out of context or they are incomplete.  Most people never bother to read the text of the article.  In fact, in this example, many of the articles written about this prediction ignored everything except the worst case scenario.  Second, most predictions, even from "experts" aren't worth the paper that they are printed on and certainly should not be used to determine how to position a portfolio.