Scapegoating: The Response to Underperformance

The institutional money management industry has a split personality.  One half is highly concentrated and stable, consisting of large banks and insurance companies offering generic products.  The other half is unstable, consisting of a large number of money managers offering active money management and specialized services.  In many ways this segment is like the market for restaurants and beauty salons, with customers always in search of new favorites and the latest hot spots.

A combination of private interests and behavioral phenomena provide the basis for the existence of this active segment.  Both frame dependence and heuristic-driven bias play major roles.

Frame dependence occurs as the sponsor divides responsibility for it’s portfolio across several active money managers.  These managers are evaluated relative to benchmarks.  The division of the portfolio gives rise to a mental accounting structure with particular reference points.  This leads investors to react more strongly to outcomes that fall below a reference point than to outcomes that lie above it.  Mental accounting also leads to the view that diversification means having variety across styles rather than maximizing expected returns subject to a fixed return variance.

An important aspect of active money management is scapegoating, or shifting regret to, the manager when returns are poor.  Given the fact that active managers underperform strategic asset allocation, the amount of underperformance may serve to measure the value of scapegoating.

Scapegoating is one explanation for why investors select active money managers.  Another is that investors are overconfident, believing the active managers they hire are likely to outperform strategic asset allocation.  

Forbes 2010 Investment Guide Backtest

It’s that time of the year again!  The time when I take out the back issues of Forbes, Fortune, Smart Money and Kiplinger to compare their hot stock, mutual fund, or ETF for the coming year to what actually happened at the end of the year.  This issue comes from Forbes’ Decemeber 14, 2009 so let’s see their hot picks!

Interestingly enough, this is their “Investment Guide” annual issue but it lacks the typical predictions on ETFs, emerging markets and alternative funds found in previous years.  The one thing they did focus on is a select few Healthcare Stocks.

The Buy

Cross Country Healthcare (CCRN):  At press time, the stock traded at $8.96.  It is trading today at $7.65.  Representing a 14% LOSS per share.

Mednax (MD): At press time, the stock traded at $57.20.  It is trading today at $64.17.  Representing a 12% GAIN per share.

Unitedhealth Group (UNH):  At press time, the stock traded at $28.97.  It is trading today at $36.89.  Representing a 27% GAIN per share.

The Sell

Boston Scientific (BSX):  At press time, the stock traded at $8.27.  It is trading today at $6.55.  Representing a 20% Reward* per share.  A reward would be realized when the investor saved money by dumping this stock if they owned it or they made a profit by shorting the stock.

Health Care Select ETF (XLV):  At press time, the ETF traded at $30.16.  It is trading today at $30.88.  Representing a 2% Missed Opportunity.

Johnson & Johnson (JNJ): At press time, the stock traded at $62.17.  Surprisingly, it is still trading at that price though it yields a pretty nice dividend of 3.47% so, technically that is a Missed Opportunity.

This backtest resulted in a below average rate of return on the buy side with +8.33%.  And, a value of +4.87% return on the sell side.  

The S&P 500’s YTD range is 1101.3 to 1223.9 which represents an 11.1% GAIN.

UPS Requires Photo IDs for Shipping

In the wake of the latest terrorist schemes to mail order a bomb, UPS is now requiring photo identification from customers shipping packages at retail locations around the world, a month after explosives made its way on to one of the company's planes.

UPS said Tuesday the move is part of an ongoing review to enhance security. The directive will apply at The UPS Store, Mail Boxes Etc. locations and other authorized shipping outlets. UPS customer centers have required government-issued photo identification since 2005.

In late October, a printer cartridge on a UPS cargo plane bound for Chicago was stopped in London after explosives were discovered. The package was later traced to a retail location in Yemen.

What can Brown do for you?

This is modified news article found at: Finance.yahoo.com

Hard Work is Here Again!

The free ride in the market is over – for those  investors relying on the sage advice of buy-and-hold.  Don’t expect to make money in the future buying just about anything.  What happened two years ago when stock prices fell through the floor was extremely atypical for stocks.  The market will likely be much more discriminating in determining whom it allows to be a “genius.”

Investors will have to know what they’re buying.  They’ll have to know why they’re buying it and best of all, they’ll have to know when to sell it.  They’ll have to make these tough decisions when the free ride comes to an end, as with what we’re seeing now.

Choppy, manipulated markets put a premium on knowledge and information.  And that means reevaluating what you own, upgrading your portfolio if need be, rebalancing to control risk, and restructuring your portfolio to reduce volatility.

An Investor’s View of Risk

In the real world, investors define risk in a variety of ways.  Mention risk, and many will begin to imagine total, irrevocable, gone-forever loss of their principal.  Fluctuation is not loss of principal.  It is just fluctuation.  Here’s an example that should make the difference clear.  Let’s say you decided that your backyard contains oil. After a million dollars spent drilling, it turns out that there is no oil.  No matter what you do, no matter how long you look at the well, no matter what happens to the price of oil, your money is gone. You have had an irrevocable loss of capital.

Let’s say that you took the same million dollars and bought a diversified investment portfolio (stocks, bonds, hedge funds, proactive asset management).  You then have an unusually bad result the first year, and lose 20 percent of your investment.  Well, you have had an interesting fluctuation, but have not had a capital loss if you can refrain from doing the very worst possible thing and pulling your money out of those investments while the values are down. 

Markets have always recovered in the past. Some took longer than originally anticipated, others faster than anyone can expect.  History indicates that all you must do to recover and go on to acceptable profits is to hang tight.  While an individual stock can go certainly to zero (think Enron, Lehman, and countless others), entire markets don’t.  Except for war or revolution, I am unaware of any market that has gone down without recovering.  As long as we expect the world’s economy to continue to move, the value of the securities markets will reflect that movement. 

Less Is More

Good asset management practices are strategic and evolutionary, not stagnant.  You must keep your long-term goals and objectives firmly in mind while allowing yourself the flexibility to evolve as new research provides better solutions to the risk management problem, or as new market opportunities present themselves.  Discipline is the key to success for the long-term investor.  He or she must not fall into the trap of managing holdings by newspaper headline, sound bites, mindless prediction, gut feelings, or last year’s results.

Developing a successful, modern investment strategy is a lot like gardening.  Both activities require patience, discipline, and faith.  Periodic reviews should be viewed as an opportunity for fine-tuning and corrections, not radical revisions and second-guessing.

How to Protect Yourself From Scam Artists

This list can be endless, but here are common ways many investors get sold on a fly-by-night investment scam.

• Never give any investment advisor a general power of attorney over your account.  Use a limited power of attorney to authorize your advisor to make trades within your account for your benefit.  There is never a reason to name an investment advisor as owner, contingent owner, or joint owner of your account.  It shouldn’t be possible for any other person to ever receive a disbursement from your account.  Your brokerage or trust company should only disburse to you at your home address or to your bank account.  Insist on confirmation of all account activity (this may not need to be sent to you by paper), but easy access to all transactions online should suffice.  Never use your investment advisor’s address as your address to receive statements.
• Select strong custodians for safekeeping of your assets.  Use major brokerage houses or trust companies that are properly insured, audited, and regulated.  Don’t let some Jabba The Hut, little financial institution act as custodian of your assets.
• Remember that if it sounds too good to be true, it probably is.  Con artists almost universally appeal to investor’s greed and unrealistic expectations.  They can’t exist without gullible people willing to believe the unbelievable.  By now you should have a good feel for the range of reasonableness in various investment markets.
• Consider carefully whether you need a guide.  Many investors shouldn’t try to go it alone.  Investing professionally is a full-time job.  It takes specialized knowledge and significant resources.  The field is rapidly evolving.  It takes a great deal of time just to keep up with the research.  Evaluate whether you have the skill, judgment, discipline, and experience to do a proper job.  Your investment plan is your future.  It’s too important to leave to amateurs.  Just because you’ve read some book on how to perform surgery does not make you a surgeon.
• Avoid commission sales.  All financial professionals get paid.  And, of course, all of them have an interest in attracting your business.  You can’t expect any of them to send you to the competition.  How they get paid, however, can have a very significant effect on the nature of their recommendations.  In fact, how you pay for advice may be much more important than how much you pay.