Advisor Blog

I just updated our website with the portfolio performance numbers through the end of 2010. 

US stocks turned in pleasing results for the full year in 2010, with investors earning significant rewards for the equity, small cap and value risk factors.  But, capturing the market rate of return required plenty of patience: eight months into the year the S&P 500 Index was still down 5.8% and the tepid economic recovery appeared to put a lid on any significant upturn in prices.  Nevertheless, stock prices surged over the subsequent five months and the S&P 500 ended the year at 1257.64, up 12.78% (price only), recouping all of its losses since the collapse of Lehman Brothers on September 15, 2008.

Results were generally similar in non-US markets, with 37 out of 45 countries tracked by MSCI achieving positive returns in both local and US dollar terms. The US ranked 22nd in dollar terms and 23rd when expressed in local currency. Peru and Thailand vied for the top spot (up 53% and 56%, respectively) while Greece and Spain landed in the cellar.

Throughout the year, investors had no trouble finding reasons to fret about the future and remain on the sidelines:

• A prominent researcher who had predicted the Great Recession was expecting the "biggest co-ordinated asset bust ever."

• An Economist cover story in January warning of asset price bubbles asserted that US stocks were "nearly 50% overvalued."

• The "January Indicator" signaled poor stock market performance for the remainder of the year.

• A tragic drilling rig explosion in April produced a disastrous and hugely expensive oil spill in the Gulf of Mexico.

• A bewildering "flash crash" on May 6th saw the Dow Jones Industrial Average plummet over 1100 points in the course of a few frantic minutes.

• Hundreds of bank failures revealed continued weakness in the financial system.

• A divided Congress passed a complex and potentially expensive healthcare reform bill.

• Residential housing remained weak, with monthly sales of new homes falling at one point to the lowest level since tracking was initiated in 1963.

• An obscure technical indicator dubbed the "Hindenburg Omen" generated a "sell" signal in August.

• North Korea launched a deadly artillery barrage in November against South Korea's Yeonpyeong Island.

• A financial crisis with no clear solution gripped governments in Greece, Portugal and Ireland.

But, for those investors who stuck to a plan, the results were very good.  The all equity Talis 100 portfolio model achieved a 21.29% return for the year, net of our highest advisory fee.  To view the rest of our performance data and important disclosures, click here.

The Talis Investment Philosophy presentation has been updated with new information and more recent return data.  The presentation discusses the failure of active management, the size and value effects in global capital markets, risk/return tradeoff in fixed income securities, the importance of minimizing costs and explains the principals of successful investing:

• Markets work
• Diversification is key
• Risk and return are related
• Portfolio structure determines performance

Click here to view the presentation.

Most potential clients are completely unaware of the bifurcated standard of care that exists between broker-dealers and Registered Investment Advisors.  Most of the so called "advisors" that work for major financial services firms are registered representatives of a broker-dealer.  Broker-dealers and their representatives are regulated by FINRA, the Financial INdustry Regulatory Authority.  FINRA is a self-regulatory organization of broker-dealers.  The standard to which FINRA regulated firms are held is called suitability.  In other words, if a product meets the FINRA definition of "suitable", it can be sold to a client.  This does not mean that it is the best product for the client.  In fact, it frequently is the product that pays the salesman (his card won't say that - he or she will be a "financial advisor" or "wealth manager" or an "asset preservation specialist", etc) the highest commission.  And, that's OK under the FINRA suitability standard.

On the other hand, Registered Investment Advisors (RIAs) are regulated by either the Securities and Exchange Commission (SEC, for larger advisors) or by the state regulatory authorities (for smaller advisors).  RIAs are held to a fiduciary standard.  The fiduciary standard is the highest standard of care under the law and requires that the RIA put the client's best interest first at all times, including putting it ahead of its own interest.

There is a vast difference between the two standards.  Knowing this, you may ask yourself why anyone would ever choose the lesser of the two.  It comes down to ignorance and obfuscation.  Most clients have no idea that the two standards exist.  Most broker-dealer representatives (aka salesmen) don't exactly go out of their way to explain it.  And, since more than 90% of the "advisors" out there are really FINRA regulated salesmen, the voice of the RIAs is often unheard through all the noise.  Nevertheless, this is extremely important and we can't imagine why anyone would choose to do business with an advisor that provides a lower standard of care.

My colleague and fellow blogger, Scott Maxwell, was at breakfast this morning and was asked a question about whole life insurance by one of his friends.  As he was busy explaining how awful an investment whole life is, he was interrupted by someone at the adjacent table who had overheard the conversation and had recently purchased a whole life policy from his insurance salesman.

Whole life is a product whose time has come and, for the most part, gone.  Think of it as a forced savings account with a relatively low fixed rate of return.  It's easy to purchase a bigger death benefit using inexpensive term insurance.  Simply investing the savings over the cost of the whole life policy will, over time, almost invariably result in far greater terminal wealth.  But, guess what?  It pays huge commissions to the insurance salesman who pitches it to the client.

The pitch goes something like this - "The stock market hasn't provided any return over the last ten years and look how great this whole life policy has done over that time period.  In addition, having your money in an insurance policy shields it from creditors and frivolous lawsuits.  The stock market is a scary and evil thing that's full of risk.  Why would you ever want to invest in stocks when you can own this safe insurance policy?" 

To begin deconstruction of the lies, the first statement involves "cherry picking" an index and using the typical dumbed down "broad brush" claim to try to convince the potential customer that the stock market has provided no return for ten years.  While that's true for a common index, the S&P 500, it's not even close to being true for a properly constructed and globally diversified portfolio.  Our Talis 100 portfolio, for example, more than doubled over this time period - net of all fees.  Not surprisingly, this return is much more than what a whole life policy earned over that time period. 

Owners of insurance policies do enjoy some protection from creditors in most states, but there are many other ways to accomplish the same thing without giving up the potential for higher returns.

Risk and return are always related.  Stocks have provided returns that far exceed any other asset class over long time periods.  Picking a ten year time period with one of the worst returns and presenting it as a reasonable expectation for the future is misleading.  But, providing misleading information is common among salesmen. 

Scott never got a chance to respond in a meaningful way to the interruption.  It would have been interesting to have this person come in and meet with us and learn more about how investing works when it's done the right way.  Unfortunately, we've found that many people are just looking for a way to validate their decisions, whether those are good or, like this one, bad.  Scottish author Charles Mackay first published the book "Extraordinary Popular Delusions and the Madness of Crowds" in 1841.  Not much has changed since then, apparently. 

DFA just announced that it will merge its US Large Company Portfolio into the US Large Company Institutional Index Portfolio on May 7, 2010.  Other than a change to the symbol from DFLCX to DFUSX, this is should be transparent to most clients.  However, it is important to note that, as a result, the expense ratio will decline by 4.5 basis points.  The expense ratio for DFLCX was already low at 15 bps, but this demonstrates DFA's continued commitment to do what is right for clients.

For most shareholders, this is a non-event.  The investment objective of both funds is the same - approximate the return of the S&P 500 index.  No action is required by shareholders.  However, since the required notifications are just being sent out, we expect to hear from clients that have questions.  That's fine, of course, and we are glad to explain this.  But, it lets us know who is paying attention to our website.  We strive to update this site frequently with useful and relevant information and commentary.  We hope you will use it!

Most of us have heard, at one time or another, about how the direction of the stock market during the month of January can be predictive of the subsequent year's market performance. This is often referred to as the "January Barometer" or something similar. But, does the data support a belief in the predictive ability of the first month of the year?

The S&P 500 index had a negative return for January 2010, provoking all kinds of speculation about the future direction of the stock market. We took a look at the performance of the S&P 500 in January from 1927 through 2010. The monthly return was negative in 31 of those years. In 15 of the 31 years with a negative January return, the annual return was actually positive. In 16 of the 31 years, the return was negative. So, how did this work as a predictor of annual market performance? About as well as flipping a coin.

What we can learn from examining historical stock returns is that they are more volatile than many investors realize. As shown in our Talis Investment Philosophy presentation (page 30), we can use 1999 as a good example. In that year, the S&P 500 posted negative returns for 5 of the 12 months, yet the annual return was a very healthy 21.04%. April 1999, one of the months with a strong positive return, had a negative return in 10 of the 21 trading days. One of those days had a negative 2.24% return. Even though this is well understood and should be expected, it's why most investors can't tolerate an all equity portfolio and it drives behavior for those that overestimate their risk tolerance that undermines long-term success.