Tag Archives: performance

Thinking In Temporal Extremes Can Be Bad For Your Wealth

Bonds, dividend investing, ETF investing, currencies “}); $$(‘#article_top_info .info_content div’)[0].insert({bottom: $(‘mover’)}); } $(‘article_top_info’).addClassName(test_version); } SeekingAlpha.Initializer.onDOMLoad(function(){ setEvents();}); We dance round in a ring and suppose, but the secret sits in the middle and knows. –Robert Frost One of the biggest problems any asset allocator must overcome is the problem of time in a portfolio. I call this the intertemporal conundrum . This describes how our financial lives are extremely dynamic and multi-temporal. That is, they are not one linear time line. Instead, they tend to be a series of short-terms inside of a long-term. This often makes the textbook application of the “long-term” inapplicable with regards to asset allocation. So, as much as we all know it’s silly to think too short-term it’s not totally irrational. After all, being involved in such dynamic financial markets gives us the urge to act and to try to take control of our outcomes in order to reduce uncertainty. We often act because we know there is an inherent short-termism in our financial lives. As I’ve stressed on many occasions , there’s no such thing as a truly “passive” portfolio. But we should be careful not to confuse this with the idea that being too short-term is intelligent. After all, we know that the financial markets tend to be highly unpredictable in the short-term. We also know that the financial markets tend to become more predictable the longer we hold onto assets. This is because the price changes involve too many random variables to be predictable in the short-term. In addition, we know that taxes and fees create potentially insurmountable hurdles so we should implement portfolios that seek to reduce these frictions as best as possible. Generally, our attempts to “take control” of our outcomes in the short-term end up costing us in the long-run. So, we want to think short-term because this gives us comfort and helps mesh with our inherently short-term financial lives. But we also know that thinking too short-term is bad for our wealth because this just churns up taxes and fees inside of highly unpredictable time frames. Then again, we know that we don’t necessarily have a textbook long-term in our financial lives. And we also know that some degree of activity will be necessary at times during the course of our lives so a static “long-term” view doesn’t mesh with inherently dynamic financial markets and financial lives. So, we have quite a temporal conundrum here. Managing this multi-temporal problem is not always easy. The textbook idea of the “long-term” doesn’t fit our financial lives. But we also know that it’s self defeating to be too short-term. So, the key involves finding that happy medium. This is why I like to think of the markets in a cyclical sense. This gives us the ability to construct portfolios that reduce tax and fee inefficiencies, but also take advantage of the fact that our financial lives are dynamic and so are the financial markets. Thinking in extremes is generally bad for your portfolio. And this is particularly important when applying the problem of time to a portfolio. And so, as is generally the case in life, we find comfort living in the extremes without realizing that the middle is often where the secret sits. Share this article with a colleague

Let’s Talk About Corporate Fraud

Summary A study predicts that 14.5% of firms, or one in seven, has insiders engaging in fraudulent behavior. They estimated a median loss of 20.4% of the enterprise value. The math of loss works harshly against investors. Rule #1 is to never lose money; Rule #2 is to refer back to Rule #1. We are all here “Seeking Alpha”, but we also want to avoid mistakes and catastrophe. One of the worst ways to lose money is due to corporate fraud. Some companies die a slow death, which you can argue is somewhat predictable, but what about getting Enron-ed? Isn’t that one of your worst fears as an investor that your stock goes to $0 overnight? When reading Intelligent Investor , one of the main concepts that jumped out to me was that numbers are highly subjective! How are you going to count depreciation, how are revenues going to be recognized, what goes off balance sheet… It depends; do you want earnings to be $900 million, $1.1 billion, or $1.3 billion? There are legal ways of playing the accounting game and illegal ways. One dangerous situation is when the executive team has compensation and bonuses tied to earnings which can be very subjective. Earnings can legally be recorded as $900 million, $1.1 billion or $1.3 billion, but if earnings come in at $1.2 billion or higher, then our CEO and the executive team get a big, fat bonus. Given the three choices, guess which earnings the company will have? That’s totally legal, but let’s take it a step further. What if the board members postulate that earnings of $1.5 billion earns our CEO a bonus? Think some creative accounting teams will take the board’s challenge and make it happen? My argument is that corporate fraud is real and that with the market hitting all-time highs – one or more big corporations are destined to go down. The market is “high”, and when the tide comes down, we will see who was swimming naked. The incentives to cheat are enhanced now, and I’d argue that it’s logical to presume that more fraud is occurring. I also seem to remember a fast-talking President make promises about cleaning up Wall Street, yet I missed the follow through part about anybody actually going to jail. Data It is very difficult to determine how rampant fraud is. How do you even quantify it? The data is not easy to find. I read an interesting study, How Pervasive is Corporate Fraud? by Dyck, Morse, and Zingales. Here are some key takeaways from their excellent study: – Over their time period studied, 4% of large publicly traded firms were eventually revealed to be engaged in fraud. They estimate that only 27.5% of fraud is detected, leading to an estimate that 14.5% of firms, or one in seven, has insiders engaging in fraudulent behavior. – They estimated a median loss of 20.4% of the enterprise value of the fraud companies was lost – measured by the firms’ enterprise value before the fraud took place as a benchmark. This puts a 3% price tag on all the value of all large corporations. – Their study found that on average 14.8% of MBA students were asked to do something illegal in their previous employment. Surprisingly, the incidence of illegal behavior did NOT vary among different industries. The only exception was a lower incidence among consumer goods, only 7% or 1/2 the fraud levels. Contrary to expectations, the financial services industry did NOT experience higher levels of illegal activity. A Forbes article echoed similar findings. “The 347 companies that were prosecuted in the decade that ended in 2007 represent a small fraction of the fraud cases that occurred.” Very few fraud cases resulted in SEC enforcement action; a lot of times the fraud resulted in shareholder disappointment, price drops, bond defaults and insolvency. Here is a top 10 list of the worst corporate accounting fraud. So why do it? The Forbes article cited the most common reasons for fraud being: – Desire to meet earnings expectations. – Hide the company’s deteriorating financial condition. – Bolster performance for pending equity or debt financing. – Increase management compensation. Clues – Frequent amendments to financial filings. – Boards chaired by the CEO. – Discrepancy between annual pay and bonus pay for CEO/CFO. – Large insider selling by top executives. – Frequent legal and regulatory issues. – Frequent turnover for officers. Among firms involved in fraud, 26% changed auditors, between the filing of their final clean financial statement and their final fraudulent financial statement. Sixty percent of the firms involved in fraud that changed auditors did so while the fraud was taking place, the other 40% changed auditors right before the fraud began. Conclusion The math of loss really works against you, the investor. If your company’s stock goes down 50% due to fraud or really any other reason, then you need a 100% return to get back to even. You could do all the due diligence in the world and still get wiped out. If auditors, regulators, insiders, board members and key employees can get duped, then so can John Q. Public the retail investor that doesn’t have access to the same information. There are certain industries that I don’t want to invest in due to their sheer complexity – financials. I like being in control, and corporate fraud takes an element of control away from you. In a ZIRP world, with top-line revenues hurting, companies cut costs down to the bone, what’s fueling earnings, buybacks? Nobody was punished during the last go around for fraudulent behavior. Big companies will go down. If anything, corporate fraud just increases the argument for diversification and never buying company stock in your 401(k) because you can never be sure. 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.

VNQI: International Equity REITs Yielding 3.85%

Summary VNQI is a far better method for international equity than buying ADRs. The Vanguard Global ex-U.S. Real Estate ETF has everything most investors would want. Intense diversification combined with strong yields. Investors need to consider the bid-ask spread when buying into an ETF, even if they are holding it for the long term. Investors need international exposure and in my opinion the best way to get that exposure is through diversified ETFs with very low expense ratios. One of the ETFs that I am personally using for my international exposure is the Vanguard Global ex-U.S. Real Estate ETF (NASDAQ: VNQI ) and I can tell you from personal experience I like the investment much better than equity investments where the ADRs (American Depositary Receipts) are charging me fees for holding the equity. Previously, those fees could only be deducted from dividends so I made the unwise move of making an equity investment through ADRs that had no dividend. If you want to know more about ADRs, read this article from Charles Schwab . The ADR is awful After the changes to allow agents to collect fees even if the underlying security did not pay a dividend, I found I had the single worst type of “investment”. This is the kind of “investment” that pulls money out of your pocket instead of putting money in. It’s like a negative dividend, and I’m less than thrilled about it. I’ve held onto that stock so I could time the sale for a tax loss and it looks like this year will be the year to do it. Due to how large the tax loss will be, I will be reaping it for years to come. I could sell smaller positions each year rather than carrying the loss across multiple years, but I’m not fond of holding any security with a negative dividend. Vanguard Global ex-U.S. Real Estate ETF is excellent Instead of providing negative cash flows, the Vanguard Global ex-U.S. Real Estate ETF is offering investors a distribution yield of 3.85%. I like the yield, I like the business model of equity REITs, and I like Vanguard as the manager of the fund for a couple reasons. Reason 1: Opaque When an ETF is going to be investing in securities that are even remotely illiquid, I would like to see some opaqueness. Vanguard does not regularly update the holdings of their ETFs and makes it more difficult for investors to know precisely what is inside the ETF. By making it more difficult for institutional investors to know what stocks will be bought and sold by the ETF, Vanguard is able to discourage front-running of their trades. If someone was able to effectively front-run the Vanguard trades, they would make some serious profits and the returns to holders of the Vanguard ETF would be marginally reduced. Even if the reduction is marginal, I don’t want any reduction in my returns. It is extremely rare that I will endorse a strategy that is more opaque, but Vanguard is one of the few companies that earned my respect over the years. It is difficult to earn my respect and very easy to lose it. I’m holding a significant portion of my portfolio in Vanguard ETFs and I trust them to be acting the best interests of the shareholders. Reason 2: Diversification Vanguard Global ex-U.S. Real Estate ETF offers investors excellent diversification through having a total of 632 holdings. Only 23.1% of the value of the ETF was invested in the top ten holdings. Only two countries represent more than 10% of the portfolio, those are Japan at 22.7% and Hong Kong at 10.8%. Reason 3: Correlation My other international investment is the Schwab International Equity ETF (NYSEARCA: SCHF ). In my opinion, SCHF is one of the best international investments available today. I’m adding to my position in SCHF to increase the international exposure of my portfolio. Vanguard Global ex-U.S. Real Estate ETF offers moderately high levels of correlation with the Schwab International Equity ETF. However, most diversified international investments show high correlation to each other. Compared to the level of correlation that I see on other international funds, the correlation for VNQI isn’t too bad. Reason 4: Bid-Ask spread When you’re buying into a position in an ETF, you’re usually stuck paying the spread. If you intend to hold the investment indefinitely, you may only need to cross the spread once. Even if you only cross the spread once, it can be a meaningful reduction in your portfolio value if the spread is significant. As I have been writing this article I checked live updates on the bid and ask for VNQI a couple times. I’ve seen the spread range from $.01 to $.03. Share prices were running around $57, so we are looking at a range of around .02% to .05% being lost to the spread. Over the long term, it is usually assumed that you would lose half the spread going in and half the spread going out. I don’t like selling long term investments with solid dividend yields, so when I buy an ETF I intend to hold it for a long time. If you don’t want the ETF in 2025, why buy it now? Reason 5: I love dividends This ETF is offering solid yields on the portfolio which is the antithesis of the negative yield on ADRs. If an investor is investing for the long term, they would be wise to look at the yield they are buying and focus on acquiring income that is both respectable in volume and highly diversified in nature. That makes VNQI a very reasonable addition to most portfolios. It offers a strong yield to go with heavily diversified holdings. Conclusion When investors need international exposure, VNQI is one of the solid options to do it. There are several factors for the ETF and only a few against it. In my opinion, the biggest drawbacks are the expense ratio and the exposure to China (around 8.28% in China). The expense ratio of .24% is much lower than competitors offering international REIT exposure, but it is also much higher than the expense ratios on any of my other ETFs. Different people build their wealth in different ways. My method was being very frugal with my money. One way that I demonstrate that frugal stance is in limiting my exposure to high expense ratios. I’m not as big on the exposure to China because I think the Chinese economy is in a bubble and I don’t want that bubble in my portfolio. To avoid that bubble, my new holdings for international exposure (outside of dividend reinvestment) will be made in the Schwab International Equity ETF. I’m more comfortable with SCHF’s allocation by country than I am with VNQI. Even though I’m focusing on acquiring more SCHF, I’m going to continue holding my shares in VNQI. I think VNQI is a solid choice for part of the international exposure in the portfolio of a tax advantaged investor. Disclosure: The author is long VNQ, SCHF. (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. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.