Tag Archives: mutual funds

Seeking Beta: The World’s #1 Passive Fund

Summary I own Vanguard’s Total Stock Market Portfolio in their 529. Here is why I own it and why everyone should consider it. You can make a tax-advantaged contribution at a significant scale. #1 Passive Fund in the World I have always mixed active investing ideas with some amount of passive market exposure. Passive exposure is cheap, simple, and tax-efficient. It also provides me with a little insurance against the results of my active ideas. My #1 favorite place to get market exposure with these benefits is Vanguard’s Total Stock Market Portfolio (MUTF: VTSMX ) within Vanguard’s 529. It has done well since inception: It is up over 50% since I discussed it as a long idea: Management Vanguard claims that, We hire top investment professionals with the experience and expertise you’d expect from Vanguard. But this is an unmanaged fund, so as long as they can keep the books straight, they could also, hire psychotic crack fiends with the experience and expertise I’d expect from San Quentin. for all that I would care. Service Their service is fine. You get 25 free trades per year if you keep over $1 million and you get 500 free trades per year if you keep over $10 million at Vanguard. They are quite generous about this status as they count the entire family’s balance towards the requisite total. In addition to the free trades, they also give you the name and phone number of a competent representative who typically can solve problems associated with such accounts. 529s A 529 savings plan is an investment account intended for college and other higher-education costs. They are sponsored by individual states and offer various tax benefits. Earnings are deferred from federal taxes. Withdrawals for qualified higher-education expenses are also tax-free. You can make up to five years’ worth of contributions at one time without triggering gift tax. The uses are pretty generous – you can use the money for tuition, room and board, books, and other expenses. Why Nevada? Nevada is one of the few remaining states without any income tax. If you have flexibility as to where you live, these are probably states worth considering. Of the bunch, Wyoming is my favorite. If one lives in Wyoming close enough to Montana to shop there, you can pay Wyoming’s zero percent income tax and Montana’s zero percent sales tax. As for Nevada, since they lack a state income tax, they cannot lure Nevadans to their 529 with promises of avoiding state income tax. Instead, they have offered every other type of inducement. Their contribution limit of $370,000 is high. Funds are removed from your estate and are exempt from creditors’ claims. They are lenient about any requirement to withdraw funds. Why Vanguard? Compared to the alternative in Nevada, Vanguard’s 529 allows you to invest in Vanguard funds. The alternative fund costs from 0.29-0.89%, while the expense ratio on my favorite Vanguard fund is 0.21%. Vanguard’s minimum initial contribution is $3,000 instead of $250, but the whole idea with this investment is to make a large investment and to hold it for a very long time. There are no enrollment fees for either Vanguard or the one alternative to Vanguard in Nevada. Why the Total Stock Market Portfolio? While this fund is highly correlated with the S&P 500 (NYSEARCA: SPY ), it is somewhat more diversified. It includes smaller capitalization companies. In doing so, it avoids some of the turnover associated with companies entering and exiting the S&P 500. That reconstitution generates trading fees and taxes. Companies included in the S&P 500 trade at a premium, which one has to pay every time one buys an S&P 500 index fund or ETF. Owning a broader based fund avoids such expenses. But whether or not you agree with my rationale, the difference is trivial: Scale This is a tax-advantaged fund 67x your IRA contribution limit. For 2015, the IRA contribution limit is $5,500 ($6,500 for people 50 or older). One might as well fund it, but the scale is small. The 529 limit is $370,000. If you are married, you can each invest $370,000 with oneself as the owner and beneficiary. At that scale, this investment has already been worth over $1.1 million since inception and over $391,000 since I last discussed it. This is an ideal vehicle for long-term tax-free compounding. Withdrawals This investment idea works well regardless of your intention for the proceeds. It works best when invested for at least a generation or longer. However, regardless of your time-horizon, it is more flexible than it first appears. There are at least five great ways to use the proceeds. 1) College for your kids and grandkids First, one can use it for its intended purpose: college, presumably for your kids or grandkids. It is easy to transfer money from one beneficiary to another. You can transfer assets in increments of $70,000 once every five years without any gift tax. Higher education is expensive and getting more expensive. It should be no surprise that we suffer under the highest inflation where there are the most third party payers. The government enters the bid side of a market with no price-sensitivity and it… increases prices: Is the expense more worrisome or is the fact that politicians fail to see the connection between their behavior and prices? In any event, it is likely that you will have higher education bills in your future. 2) College for yourself Secondly, you can spend the money on yourself. Whether or not you have kids or grandkids (or have any inclination to subsidize said kids/grandkids), you can still save the money in a 529 and spend it on… your own bad self. Courses in wine tasting and golf in an idyllic college town would not be terrible. 3) College as philanthropy Thirdly, you can give the money away. Even if you do not want to spend it on either your progeny or yourself, this would make a perfect foundation for your philanthropic educational efforts. Whether or not you will have college bills to pay, someone certainly will. You will be able to help them. 4) Future expanded usage Fourth, it is reasonably likely that the hodgepodge of tax-advantaged accounts will be simplified and consolidated in the future. If this one is consolidated with others intended for retirement or healthcare, then the limitations on usage will have effectively disappeared. Over the next fifty years, this is highly likely. 5) Just pay the penalty… you will still come out ahead Fifth and finally, you can simply pay the penalty. But here is where this idea gets really interesting, in fact dominant as a strategy: the penalty is too small . Federal law imposes a 10% penalty on earnings for non-qualified distributions. While I never plan to pay this penalty, the value of 10% of the earnings on the back end will probably be far less than the value of compounding tax-free in the interim decades. Even if you intend to spend the money on wine, women, and song (and fail to find an anthropology course “Wine, Women & Song 101”), then you can compound tax-free, pay the penalty, and still end up ahead. Scholarship Encouragement If your kids fully expect that you will pay for college, it can be harder to encourage them to find scholarships. There are piles of scholarship dollars everywhere for almost every type of kid. The key is for them to be motivated to find it and get it. If they receive a scholarship, then the penalty for withdrawing money from a 529 is waived. My hope is that my kids attend military academies (also that my daughter elopes). If the plan succeeds, then there are decades ahead of tax-free compounding without any restriction on some withdrawals. In order to interest them, I am offering each kid half of whatever they earn in scholarship money. Conclusion If you max out your 529 contribution and then wait for a long time, you will benefit from tax-free compounding at a significant scale. At the same time, the cost of the limitations on withdrawals is manageable. With that base of passive market exposure, one can turn to active ideas. My best ones are here . Disclosure: I am/we are long VTSMX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital. Rangeley invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our investors, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.

PRIDX: A Good Way To Invest In High-Quality Small Caps

Summary A recent research study found that higher-quality smaller companies have outperformed higher-quality larger companies. PRIDX has generally outperformed its global small/mid cap benchmark. PRIDX has been experiencing fund inflows and strong relative strength. Overall Objective and Strategy The primary objective of the T. Rowe Price International Discovery Fund (MUTF: PRIDX ) is long term growth of capital through investments in common stocks of rapidly growing, small to medium-sized companies outside the U.S. They look for high-quality growth stocks that can compound returns beyond the typical one- or two-year time horizons of most investors. Smaller companies throughout the world can react relatively quickly to changes in the marketplace and the economy, which may give them an edge to capitalize on investment opportunities faster than their larger counterparts. The fund has a fairly high risk profile because of its investments in small caps and some less-developed countries. Aside from market risk, there are also risks associated with unfavorable currency exchange rates and political or economic uncertainty abroad. Fund Expenses PRIDX is a no-load fund. The expense ratio for PRIDX is 1.21% which is higher than I like, but not bad compared to other actively managed international small/mid cap funds. Minimum Investment PRIDX has a minimum initial investment of $2,500 in a taxable account, and $1,000 for a group IRA. Past Performance PRIDX is classified by Morningstar in the “Foreign Small/Mid Growth” or FR category. Compared with other mutual funds in this category, PRIDX has performed fairly well. These are the annual performance figures computed by Morningstar since 2007. 2007 2008 2009 2010 2011 2012 2013 2014 YTD PRIDX (%) 16.57 -49.93 55.69 20.47 -14.08 26.00 24.37 -0.43 10.80 Category (FR) 12.03 -49.02 49.24 23.04 -14.72 22.20 26.61 -5.40 9.75 Percentile Rank 34 58 17 77 31 11 60 15 56 Source: Morningstar Mutual Fund Ratings Lipper Ranking : Funds are ranked based on total return within a universe of funds with similar investment objectives. The Lipper peer group is International Small-Cap 1 Yr – #19 out of 168 funds 5 Yr – #31 out of 122 funds 10 Yr – #11 out of 67 funds Morningstar Ratings : Category is Foreign Small/Mid Growth Overall 5 Stars Out of 130 funds 3 Year – 4 Stars Out of 130 funds 5 Year – 4 Stars Out of 113 funds 10 Year – 5 Stars Out of 67 funds Fund Management Justin Thomson has managed the fund since August, 1998. He has an M.A. from the University of Cambridge. Regional Exposure (as of May 31, 2015) Europe 41.3% Pacific Ex-Japan 26.1% Japan 21.2% Latin America 2.7% North America 1.7% Middle East & Africa 1.0% Country Exposure (as of May 31, 2015) Japan 21.2% United Kingdom 15.7% China 8.4% Germany 5.8% India 4.1% France 3.4% Spain 3.4% South Korea 3.0% Australia 2.9% Switzerland 2.9% Comments PRIDX is a good way for individual investors to gain exposure to rapidly growing small/mid cap companies outside the U.S. It would be very difficult and costly for retail investors to purchase most of the stocks in this fund individually, given the complexities of foreign stock exchanges, currency conversions etc. I discovered PRIDX from a relative strength trend model run on the funds in the Citigroup 401K plan. PRIDX has recently popped up to the top of the list, and there are also signs that the fund has been attracting inflows lately. Here are some recent assets under management figures for PRIDX taken from the fundmojo web site: Feb. 2015 $3.53 Billion Mar. 2015 $3.88 Billion Apr. 2015 $4.12 Billion May 2015 $4.28 Billion I believe that if new money continues to flow into international small cap funds, it will boost the performance of the underlying stocks in the PRIDX portfolio. Back in January, hedge fund AQR and Tobias Moskowitz, a finance professor at Chicago’s Booth School of Business, published a research paper entitled ” Size Matters, If You Control Your Junk “. It found that small companies have outperformed larger companies when the quality of the companies is taken into account. Of course, it is well known that businesses with steady earnings greatly outperform highly speculative penny stocks. But when comparing companies in the same industry, the small, high-quality companies have outperformed larger, high-quality companies. I believe that PRIDX is a good way to invest globally in stocks of smaller, higher-quality companies. If it continues to attract inflows, this should benefit fund performance. Disclosure: I am/we are long PRIDX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

How To Select Funds That Fit

By Detlef Glow Since my colleague Jake Moeller, Lipper’s Head of Research for the U.K. & Ireland, wrote in his last Monday Morning Memo about the reasons an investor might sell a fund , I thought it would be worthwhile to write about the initial fund selection. To find a suitable fund it is necessary that the purpose for which the fund is being bought is clearly defined and that investors know their preferred performance profile. Quantitative Research Once the decision to invest in a given asset type or sector has been made, investors have to find the fund(s) that best suit best their needs. Since in some sectors there are hundreds of funds available to investors, it is necessary to narrow the investment universe by using a quantitative research process to evaluate fund performance. Fund Classification To evaluate the performance of a mutual fund an investor must compare the performance of the fund to the performance of the appropriate market and other funds with the same or similar investment objectives. This means an investor needs to compare apples to apples-or even better, green apples with green apples and red apples with red ones-to employ a proper quantitative screening process. Even though this sounds very simple, it is a rather difficult task , since investors need to take into account that funds with the same investment objective might use different techniques (such as hedging strategies) to achieve their goals. To find a proper classification becomes even harder, when one is looking at alternative UCITS or multi-asset funds. These funds might have the same investment objective but employ totally different sources to generate returns, meaning that the funds might contain totally different risk factors. In this regard, it is important that the investor not only looks at the asset type and investment objective when he tries to classify a fund, he also needs to look at the performance and risk drivers within the portfolio. The fund prospectus is only a starting point for the fund classification, since the prospectus gives the investor only a general idea of what the fund manager can or can’t do to achieve particular goals. The second step must be to view a detailed presentation, since that is the only way to understand what the fund manager is doing, especially in regard to rather complex products. In addition, one needs to monitor the holdings of the fund to see if there is any style drift and/or change of investment focus within the portfolio. Performance Measurement Even though past performance is no guarantee of future performance, past performance is the only source telling an investor how a fund has behaved in different market environments. Past performance is the only source for evaluating the risk/return profile of a fund. It is necessary that the investor use a period with enough data points to show statistically relevant results. A number of investors prefer monthly data for a three- to five-year period, i.e., 36 to 60 data points, to evaluate the performance of a fund. Even though it seems this number of data points is rather small, this period might be more relevant to evaluate the performance of a fund than longer periods; the fund manager or parts of the process might change during longer periods, which would falsify the results of the quantitative research. To evaluate the performance of a fund in comparison to the underlying market and its peers, it is necessary to analyze a number of non-overlapping periods in both bull and bear markets. Only in this way can the length and the magnitude of an out- or underperformance in the given market environment be measured to gain an understanding of the performance profile of a fund during different phases of a market cycle. In addition to the “plain-vanilla” evaluation of performance, some investors also use risk-adjusted ratios such as the information or Sharpe ratio to assess a fund. Pitfalls of Ratios If an investor uses risk-adjusted ratios in addition to plain-vanilla performance measures, the investor needs to understand in detail the formula behind the ratio and to ensure that the employed ratio works in all market conditions. One example is the often-quoted Sharpe ratio. Professional investors know the weaknesses of this ratio in negative-performance environments and would rather use an alternative measure such as the Israelsen ratio to determine the risk-adjusted performance of a fund. Since the Sharpe ratio is often used by the media or on Internet platforms, private investors and their advisors are often unaware that they shouldn’t use the ratio in negative-performance environments. Fund Ratings Some investors try to take a shortcut in the quantitative research process by using quantitative fund ratings from independent rating providers, since these ratings are often available free of charge. But this is not the purpose of the ratings. Any quantitative rating is a measure that should give the investor a hint of which funds are the best under the constraints of the methodology used to evaluate the funds in a given peer group. The measures employed in the given methodology might or might not suit the needs of the investor. In this regard, an investor must have a detailed understanding of the measures used in any given fund rating in order to use the rating in a fund selection process, even as a supplement to an individual fund assessment process. From my point of view, a fund rating or even a fund award should be used along with other quantitative measures, but it should never be used as the only criterion to select a fund; normally, no fund-rating methodology completely meets the needs of an individual investor. After the quantitative assessment of a given peer group the investor needs to verify the results and analyze the most suitable funds in more detail to find the fund that best suits a particular purpose. This second step in the fund research process is the qualitative research. Qualitative Research The qualitative research process begins with the fund prospectus, since the prospectus can give the investor detailed information on which derivatives or security lending strategies a fund manager can employ to enhance the performance of the fund. Because of the language used in the standard fund prospectus, it is often difficult to extract this information. The next step in the process is to send a questionnaire, the so-called request for proposal (RFP), to the asset management company to gain more detailed insight into the wider fund management process. The questionnaire should not only contain questions on staff turnover, changes in the management style, or the management and research process, it might also contain questions on the company’s share- and stakeholder structure. One important point that should be covered in the questionnaire is the risk management process employed by the asset manager, since that process might be the key to achieving the risk targets of the fund and/or to keep the fund in line with the expected general risk profile. The RFP might also contain questions about the general policies of the asset manager, such as exercising shareholder voting rights , etc. This approach also applies to investors who favor passive products, since the investor needs to understand in detail the methodology used to determine the index constituents and their weightings within the index, as well as the general policy of the fund with regard to the use of derivatives and security lending strategies. To complete the qualitative assessment the investor needs to interview the fund manager. While the first contact should be in person, updates can be done over the phone. The first interview can be done at the investor’s office or as an onsite visit to the fund by the investor. Even though it is more convenient to have the fund manager go to the investor’s office, I personally prefer to make onsite visits, since they give the opportunity to speak to other key staff such as analysts and the risk manager to gain even more detailed insight on the management and research process and to validate the answers given in the RFP. By the way, it can be great fun to ask the fund manager during a one-on-one interview the same questions as in the RFP, since the fund manager might give different answers to the same questions. With regard to a deeper understanding of what is going on in the portfolio, it is worthwhile to review the holdings of the fund and to challenge the fund manager with questions on holdings that do not look suitable for a particular investment approach. Since the whole process is done to understand in detail what a fund manager is doing to outperform the market and his peers as well as to get an idea of when a fund is likely to out- or underperform a particular management approach, investors need to develop their own standards for quantitative and qualitative research. From my point of view, the quantitative and qualitative fund research goes hand in hand for fund selection, since neither one can answer all the questions on its own. But in conjunction the two approaches can deliver a very clear picture of whether a fund is suitable for a given investor. Investors looking at the same performance numbers might come to the same conclusion regarding the quantitative research, but since qualitative research is driven individually according to specific requirements, the results of this process can differ widely between investors. The views expressed are the views of the author, not necessarily those of Thomson Reuters.