Tag Archives: mutual-fund

The Big Lesson From A Bet With Warren Buffett

Seven years ago Ted Seides made a bet with Warren Buffett that a fund of hedge funds could outperform the S&P 500 over a ten-year period. As of today, that bet is looking very bad, with the S&P 500 beating the fund of funds by over 40% (63.5% vs. 19.6%). Seides wrote a piece for CFA Institute explaining why the bet has been wrong and some lessons from it. While Seides makes many good points, there’s one lesson that is particularly important in all of this: Seides explains that half of the underperformance is from fees: Just over half (24.4% ÷ 43.9% = 55.6%) of the underperformance by hedge funds can be attributed to fees. A full 19.5% of cumulative underperformance, or approximately 2.6% per annum, must have been caused by something else. That’s not exactly a glowing endorsement for high fee funds. Why would anyone pay more for less? The fact is, the investment world has become dirt cheap. You can get good financial advice for a fraction of the fee that you once had to pay. The entire hedge fund industry is living in the past, hoping to continue to suck 2&20 out of their unwitting clients for as long as they can. The reality is that you don’t have to pay high fees for smart advice any longer. Heck, I offer my asset management service for a measly 0.35% and I’d say I am a pretty “sophisticated” thinker. That’s what my mother tells me anyhow and I believe everything she says. More importantly, we’re entering a world where future returns are likely to be lower in the future. With bonds generating low yields, a balanced portfolio is either going to produce lower returns in the future or higher volatility returns as more of the gain is made up by stocks. This creates a problem for investors. If you’re paying high fees, you’re either paying more for lower risk adjusted returns OR your fees are eating into your returns by an increasingly large margin. If you’re looking at a real return (after inflation) of 6%-7% in stocks, then we have every reason to be mindful of any other frictions like taxes and fees that might reduce that return even further. But what is the average fee effect? To put things in perspective, consider that the average mutual fund charges 0.9% relative to the average low fee index which charges 0.1%. That’s a 0.8% difference. It doesn’t sound like much, but take a 7% compound annual growth rate on $100,000 and extend that over 30 years. Just how much of an impact does it make? The mutual fund ends up with a balance that is 23% lower than the index. In other words, the mutual fund could just mimic the return of the index and reduce your return by $150,000! Either way, the solution is simple. Stop paying high fees. My general rule of thumb is that you should almost never pay more than 0.5% for portfolio management. If you’re paying more than that, then I highly doubt you’re getting your money’s worth. Are you Bullish or Bearish on ? Bullish Bearish Neutral Results for ( ) Thanks for sharing your thoughts. Submit & View Results Skip to results » Share this article with a colleague

Investing For Retirement Using Schwab Mutual Funds

Summary Schwab offers a set of diversified mutual funds which can be successfully used for construction of investment portfolios with good withdrawal rates. A set of just three mutual funds, a bond, a large cap dividend equity growth, plus a small cap fund generates good returns with relatively low risk. From January 2005 to January 2015, a Schwab portfolio with fixed allocation could produce a safe 5% annual without any substantial decrease of the capital. Same portfolio with rebalancing at 25% deviation from the target allowed a safe 5% annual withdrawal rate with a smaller decrease of the capital. Same portfolio with momentum-based adaptive allocation could have produced a safe 10% annual withdrawal rate and 0.52% annual increase of the capital. This article belongs to a series of articles dedicated for investing in various mutual fund families. In previous articles we reported our research on Fidelity, Vanguard, T Rowe Price, and American Century mutual fund families. The current article does the same for Schwab family of mutual funds. The series of these articles is aimed at a broad spectrum of investors. They may be useful to small individual investors as well as to any large institution managing retirement accounts. The general methodology we use in selecting the funds for the portfolio was presented in a previous article. The portfolio includes three funds: one bond fund and two equity funds. The equity funds are complementary: one covers large capitalization stocks paying high dividends, the other fund contains small capitalization growth stocks. Historically, the selected funds have performed better than most other funds in their category. The mutual funds been selected for investment are the following: Schwab total bond market fund (MUTF: SWLBX ) Schwab Dividend Equity fund (MUTF: SWSCX ) Schwab Small Cap Equity fund (MUTF: SWDSX ) As in the previous articles, three different strategies are considered: (1) Fixed asset allocation. The portfolio is initially invested 50% in the bond fund and 50% equally divided between the two stock funds, without rebalancing. (2) Target asset allocation with rebalancing. The portfolio is initially invested 50% in the bond fund and 50% equally divided between the two stock funds and is rebalanced when the allocation to any fund deviates by 25% from its target. (3) Momentum-based adaptive asset allocation. The portfolio is at all times invested 100% in only one fund. The switching, if necessary, is done monthly at closing of the last trading day of the month. All money is invested in the fund with the highest return over the previous 3 months. The data for the study were downloaded from Yahoo Finance on the Historical Prices menu for three tickers: SWLBX, SWSCX, and SWDSX. We use the monthly price data from January 2005 to January 2015, adjusted for dividend payments. The paper is made up of two parts. In part I, we examine the performance of portfolios without any income withdrawal. In part II, we examine the performance of portfolios when income is extracted periodically from the accounts. Part I: Portfolios without withdrawals We report the performance of the portfolios under two scenarios: (1) no withdrawals are made during the time interval of the study, and (2) withdrawals at a fixed rate of the initial investment are made periodically. In table 1 we show the results of the portfolios managed for 10 years, from January 2005 to January 2015. Table 1. Portfolios without withdrawals 2005 – 2015. Strategy Total increase% CAGR% Number trades MaxDD% Fixed-no rebalance 79.75 5.98 0 -31.09 Target-25% rebalance 86.22 6.36 3 -31.09 Momentum-Adaptive 247.20 13.25 36 -14.74 The time evolution of the equity in the portfolios is shown in Figure 1. (click to enlarge) Figure 1. Equities of portfolios without withdrawals. Source: This chart is based on EXCEL calculations using the adjusted monthly closing share prices of securities. From figure 1 it is apparent that the rate of increase of the adaptive portfolio is substantially greater than the rate of the fixed and target allocation portfolios. Part II: Portfolios with withdrawals Assume that we invest $1,000,000 for income in retirement. We plan to withdraw monthly a fixed percentage of the initial investment. That amount is increased by 2% annually in order to account for inflation. In table 2 we show the results of the portfolios managed for 10 years, from January 2005 to January 2015. Money was withdrawn monthly at a 5% annual rate of the initial investment plus a 2% inflation adjustment. Over the 10 years from January 2005 to January 2015, a total of $535,920 was withdrawn. Table 2. Portfolios with 5% annual withdrawal rate 2005 – 2015. Strategy Total increase% CAGR% Number trades MaxDD% Fixed-no rebalance -0.21 -0.02 0 -36.32 Target-25% rebalance -0.01 -0.00 3 -37.39 Momentum-Adaptive 126.32 8.51 36 -20.50 The time evolution of the equity in the portfolios is shown in Figure 2. (click to enlarge) Figure 2. Equities of portfolios with 5% annual withdrawal rates. Source: This chart is based on EXCEL calculations using the adjusted monthly closing share prices of securities. To illustrate the advantage of the adaptive allocation strategy and the effect of withdrawal rates on the evolution of the capital, we give in Table 3 the results of simulations for the following withdrawal rates: 0%, 5%, 10%, and 12%. Table 3. Adaptive Portfolios with various annual withdrawal rates 2005 – 2015. Withdrawal rate % Total increase% CAGR% MaxDD% 0 247.20 13.25 -14.74 5 126.32 8.51 -20.50 8 53.77 4.40 -25.64 10 5.40 0.52 -30.04 The time evolution of the equity in the portfolios is shown in Figure 3. (click to enlarge) Figure 3. Equities of momentum-based portfolios with various annual withdrawal rates. Source: This chart is based on EXCEL calculations using the adjusted monthly closing share prices of securities. Conclusion The set of three Schwab mutual funds, selected for this study, perform well for all three strategies and generate sustainable returns at relatively low drawdowns. Between 2005 and 2015, the fixed target allocation with rebalancing was able to sustain withdrawal rates of up to 5% annually. The adaptive allocation algorithm was able to sustain withdrawal rates up to 10% annually without any decrease of capital. Additional disclosure: This article is the fifth in a sequence on investing in mutual funds for retirement accounts. To help the reader compare the past performance of various mutual fund families, I selected a benchmark 10-year time interval starting on 1 January 2005 and ending on 31 December 2014. The article was written for educational purposes and should not be considered as specific investment advice. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Third Avenue Focused Credit Tackles Distressed Debt

Summary TFCVX targets stressed and distressed securities, with more than half of the portfolio classified as “special situation”. Active management is a must in this area. The fund currently yields more than 10%. Third Avenue Focused Credit (MUTF: TFCVX ) is an aggressive high-yield bond fund with a focus on stressed and distressed securities. The fund seeks to deliver total return, not current yield. Strategy TFCVX’s strategy rests on what the firm calls the “Fulcrum Security…the most senior security that will likely convert into equity ownership in a restructuring.” Managers look for discounted debt securities that stand a good chance of being paid at par value in cases where the firm’s fortunes turn around, or stand a good chance of being converted to equity in a restructuring. They shy away from holding the highest-yielding debt in a company, since that debt could expire worthless, but they will also shy away from the lowest-yielding senior debt, since it doesn’t offer as attractive a yield. The fund’s sweet spot are the securities that turn into equity in a restructuring. Profit mainly comes from one of two paths: collect hefty coupon payments and see some gain on the principal, or get a controlling interest in a company as it emerges from bankruptcy or restructuring, with the opportunity for even larger upside. The big risks inherent in the strategy comes from the fact that it’s impossible to know which security will be the “Fulcrum Security” ahead of time, along with the difficulty in estimating the future value of a firm post-restructuring. Additionally, the fund is dealing in sometimes illiquid securities or opaque situations, such as a bankruptcy fight in court. Lead manager Tom Lapointe was named a 2014 Rising Star of Mutual Funds by Institutional Investor. He previously served as co-head of High-Yield Investments for Columbia Management. Portfolio As of December 31, TFCVX had $2.37 billion under management. The fund is fairly concentrated for a bond fund, with only 86 holdings. The top ten holdings accounted for 38.3 percent of assets . (click to enlarge) One of the portfolio statistics that sticks out is the $76.01 average price of securities in the fund versus the par value of $100, highlighting the fund’s ownership of distressed securities. Only 18.9 percent of the portfolio was in performing securities, with 51.7 percent classified as special situations. While TFCVX has a high yield today, the fund’s mandate and stated strategy targets total returns, which could involve holding non-income paying equities received as part of a restructuring. There is no guarantee of income, and income could decline substantially if bankruptcies increased and the fund converts debt to equity. Payouts have been in a general uptrend since inception in 2009, but this a period when the market for high-yield debt improved, allowing firms to restructure debt without declaring bankruptcy. Were there to be a period of economic stress or a deep recession, more of the fund’s holdings may become special situations, with debt converting into equity, lowering income payments. The fund’s mandate requires it to hold 80 percent of assets in credit instruments. Under the guidelines of this mandate, equity and convertible bonds acquired as part of a restructuring will be classified as credit instruments. Equities are currently only 13.7 percent of assets, but this could rise substantially under the funds mandate, materially impacting the fund’s yield. In a period of relative tranquility for high-yield debt, TFCVX has a 3-year standard deviation of 7.40 versus 4.83 for the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and 2.85 for the Barclays U.S. Aggregate Bond Index. TFCVX has a 3-year beta of 0.01 versus the Barclays U.S. Aggregate Bond Index. HYG has a beta of 0.57 versus the same index. Compared to the Credit Suisse High-Yield Index, TFCVX has a beta of 1.16. The fund is volatile and correlated with high-yield bonds, but is less correlated to the overall bond market than other high-yield bond funds. TFCVX In A Nutshell This bit from the October 2014 shareholder letter shows why investors interested in the distressed debt market would do well to invest with capable managers (emphasis mine): We initiated a position in Ideal Standard in December 2013 at a 70% discount to where Bain had invested. We were able to accumulate 25% of the notes that we believed would be (and in the end were) the fulcrum (11.75% EUR Senior Secured Notes), buying from investors selling off the company on liquidity concerns. Up until this point this was a fairly routine investment. Complications started when the company went into reorganization and initiated an exchange offer that did not allow minority note holders, such as Third Avenue, to participate in the equity, and intended to leave us with a high-yielding fixed income instrument only. We contested this exchange offer and threatened a legal action in the US. This gave us leverage; we were able to negotiate revisions to the exchange offer that allowed us to get a 20% stake in the equity. The restructuring was completed in spring 2014. The recapitalization values the company at $500 million today. We believe this investment, a 2.1% position in the Fund as of October 31, 2014, has significant upside and limited downside. Investing in distressed debt requires a lot of homework, but even if an investor finds an undervalued security, courts and lawyers may change the facts on the ground. Small investors are unable to influence this process, but fund managers can and do influence these situations in favor of their investors. Managers are also able to grab opportunities that small investors cannot access. In another example from the shareholder letter , the fund made a bridge loan to a firm in distress, an investment opportunity that small investors cannot access on their own. Performance Warren Buffett famously said that the market was a voting machine in the short term, but a weighing machine in the long term. Third Avenue Focused Credit is a perfect illustration of this maxim at work because managers of TFCVX are engaged in long-term investments in distressed credit, but the securities they hold are subject to daily pricing. Since the outcome of distressed credit is highly volatile, with a high probability of bankruptcy, pricing of securities will be volatile. Even if investors have a high risk tolerance, they also need a long-term outlook in order to profit from the strategy employed by TFCVX because managers need time to unlock the fundamental value in these securities. As the case of Ideal Standard shows, it was not timing or even fundamental analysis that ultimately turned the position into a winner, but the threat of legal action. The value of securities held by TFCVX may be in “limbo” at times due to outstanding court cases and legal claims, leading to wild price fluctuations. Market prices for the debt held in TFCVX may deviate substantially from the underlying value, particularly when the resolution is unclear and the broader market is experiencing a bout of fear. The high-yield debt market is currently experiencing some risk aversion and the recent drop in TFCVX has led it to underperform the iShares iBoxx $ High Yield Corporate Bond ETF. (click to enlarge) The underperformance is due to the past seven months of turmoil in the high-yield debt market, influenced by the plunge in oil prices. To give a little clearer picture, in this chart, the red line represents the price ratio between HYG and the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ). A rising line indicates HYG is outperforming. (click to enlarge) TFCVX is more sensitive to changes in investors’ risk appetites. Investors have gravitated towards investment-grade bonds and U.S. Treasuries over the past seven months, and the riskier TFCVX has suffered as a result. Fees And Expenses TFCVX has an expense ratio of 1.16 percent, which includes a management fee of 0.75 percent and a 12b-1 fee of 0.25 percent. This is a high fee relative to the high-yield bond category, but is not excessive considering the specialized nature of the fund. There is also a 2 percent short-term redemption fee on shares held less than 60 days. Conclusion TFCVX is a high-risk, high-potential reward fund. The fund opens a part of the debt market that is largely closed to small investors, one that can deliver attractive returns over the long term and add some diversification to an already well-diversified portfolio. Investors interested in TFCVX must be ready to sit through volatility. Many funds have short-term trading fees in order to reduce volatility, and TFCVX is no exception, but the negative effect from share redemptions would be amplified during a liquidity crunch in the high-yield bond market. Investors who are not comfortable with a long-term buy-and-hold approach would be better off in a more liquid high-yield bond fund. For those investors looking for total return and capital gains, TFCVX is a unique fund worth considering. The recent drop in price presents a good entry point for long-term investors. TFCVX has suffered due to risk aversion in the bond market, but the fund will rebound when demand for high-yield credit recovers. (click to enlarge) Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.