The Board of Visitors was estabilished in 1966 with the purpose of bringing together a dynamic group of advisors to Berry College. The Board of Visitors meets annually to provide insights and perspectives on a wide range of issues. This input helps Berry College fulfill its mission to integrate academics with a strong work experience, community service and oppertunities for spiritual growth.

This report shows that only on third of funds managers had a positive alpha over the last three years. The report also goes on to show that expenses and taxes greatly degrade fund performance. Another interesting note is that active fund managers tend to outperform in poor performing areas of the market, but in “hot” areas they tend not to keep up with the index.

Overall, there is really nothing new, just a reminder that low cost passive investing should have a place in everyone’s portfolio. This report supports the Wiser investment philosophy of maintaining a diversified portfolio, keep cost low and always invest for the long term.

VIEW THE REPORT HERE

Those investors looking to invest in ETFs, but still only desire to support companies within their values can now turn to a company called Faith Shares.  Faith Shares has recently launched five new ETFs that invest with Christian values in mind.  The company’s product line includes a Catholic Values Fund, Baptist Values Fund, Christian Values Fund, Lutheran Values Fund and the Methodist Values Fund.

All funds are built by selecting the 400 largest US companies.  These companies are screened by the fund’s religious values and then ranked by their Environmental, Social, and Governance (ESG) score by industry.  The companies are then sorted by industry in a way that mirrors the FTSE US Index.  The top 100 stocks will make up the fund, allocated at 1% each.  The passively managed portfolios will be rebalanced and could have company changes each June.

This equal weighted approach to investing allows the funds to be non-cap size biased.  In comparison, the S&P 500 (SPY) ranks companies by size, thus the investor has a larger portion of the mega size companies.  The equaled weighted approach (RSP) has outperformed the traditional S&P 500 weightings 1.54% to 0.41% over the last five years.  However, because the equal weighted approach allocates with smaller companies, there is additional risk.  The five-year Standard Deviation of the S&P 500 is 16.0 whereas the equal weighted approach is 19.96 (as of 2/12/2010 comparing SPY to RSP as Faith Shares does not have an actual 5 year record).

The funds have virtually the same holdings with a few minor differences.  For example, the Baptist funds is restricted to hold alcohol companies while the Catholic fund will.  Investing with your values in mind certainly does not come without a price, though.  The ETFs currently have an exceptionally high cost of 0.87% in annual management fees.  In comparison, the S&P 500 index (SPY) is less than 0.10%.  Faith Shares does donate 10% of its funds revenue to a charity and hopes to lower the fee as assets grow.

Faith Shares is also planning a launch of an international product in the near future.  Currently, Faith Shares has the only Christian faith based ETF product line on the market.  The company’s website nor third party sites show the size of the ETFs, so due to the newness of the funds we assume that the assets in each fund are less than $100 million.  This throws up a caution flag.  We can see that the daily trading volume of the funds is relatively low, so if you want to trade this ETF, make sure that you use limit orders based on the intra day value of the fund.

With proper trading techniques and a realization that these funds should complement a bigger asset allocation strategy, these funds should fit well with faith-based investors.  My biggest issue is the fee. Hopefully with success, Faith Shares will do the right thing and lower the fee below 0.50%.  Below 0.20% seems even more reasonable.

The speaker at the ERT February 25th dinner is David M. Ratcliffe. David M. Ratcliffe is the CEO of the Southern Company, a leading U.S. producer of electricity. Elected by the board of directors in December 2003, Ratcliffe became president of Southern Company in April 2004 and assumed the additional responsibilities of CEO and chairman in July 2004. Tickets to the event are $30.

To clarify, there is nothing wrong with selling products, many salesman have become successful by being honest when others are not and by giving honest opinions even when it means they don’t get the business.

However, would you see a cancer doctor who was only compensated by selling drugs by certain drug manufactures?  Would you hire a lawyer that was selling something?

So, why would we seek investment advice from those whose main source of revenue comes from selling mutual funds, annuities, and stocks trades?  This happens all the time, under the guise of “Financial Advisor”.

Not all Brokers take advantage of clients; they usually just do not have the freedom not to.

Trading Tips

A while back on the Front page of the Wall Street Journal was an article uncovering some disturbing practices by Goldman Sachs.  Goldman Sachs has been sending out written research reports by its analyst to thousands of its clients, all the while holding weekly analyst conference calls with select clients called the “trading Huddle”.  During these conference calls analyst give their true opinions about company stocks, the overall market, and which stocks are likely to rise in value over the short run.  Often these conference calls go against the written reports.

There is also an example given that after one day after the Janus Capital Group, Inc was given a neutral rating, research analysts called 50 of the firm’s selected clients to tell them the stock was likely to move higher.  Unfortunately, news leaks out like this all the time, where unethical practices take advantage of clients to the gain of the company.

Other major brokerage houses do the same thing; however they disclose that they may give advice to premium-paying clients that differs from the written reports.

T.V. Selling

When you watch interviews with CEOs and leading market strategist they explain with great enthusiasm what they are doing for their clients-today. To be clear, chief strategist and research analysts are hired by large security firms to sell advice to clients in order to generate income through the trading of stocks and bonds.

Something that drove this home for me was one day a guest host-a chief strategist for some well-known securities firm, said in a very long winded speech that he agreed with others at the table that traders should raise their cash allocations but should do so by taking a short position in their stocks equal to their long position in order to quickly reenter the market when they became more bullish.  If you’re confused about this, know that I am too.

Close to Home

We use TD Ameritrade to hold all our client’s assets and also use them to execute transactions for us.  TD Ameritrade is responsible for a large percentage of daily trading on the US stock exchanges.  They have two main “sides” to the business; retail and institutional.  Retail, is for individuals to keep traditional and Roth IRAs at or to have a regular trading account at.  Institutional is for professional money managers to keep asset there, this is called a custodial relationship.  The institutional side has many features and functions retail investors do not have access to.

The main difference between the two sides is that, the retail side of individuals is flooded with reports and features for the technical, frequently trading, active investor.  On the institutional side there is no such push or functionality for this kind of charting.  Why? Because most professionals, who do not receive compensation for trades, do not invest clients’ assets in this way.

Most, independent money management firms invest with a long term outlook.  This is true of most pension consulting groups, endowments, bank trusts, mutual funds, and privately, financial journalist.

The reason for this difference is because TD Ameritrade receives a very reasonable $9.99 per trade.

What It Comes Down To

The problem with financial advice comes down to this fact; advice should be paid for separately from products and products should not pay the advice giver.  And guess what, the overall cost of paying for independent advice will most certainly cost less than the expensive products being sold to you.

An industry word we throw around a lot called fiduciary is the difference here.  Doctors, lawyers and even real estate agents have this same standard.  Fiduciary means to act on someone else’s behalf, simply to act in a person’s best interest.  Brokerage houses have a lot of power in lobbying to Washington and have thus far kept themselves out of being fiduciaries to clients.

What most independent, fee-only, Registered Investment Advisors see as the largest problem, is that the general public and many politicians see brokers and Registered Investment Advisors the same.  Brokers, for years now have put “Financial Advisor” on the business cards and in their titles.  Titles like financial advisor and financial planner blur the lines between the two.  All major brokerage houses run commercials that further blur the lines.  Many people, now, are not even aware that there is anything else.

Many clients that come to us from Brokerage houses are confused when we plainly disclose the predetermined fees we bill them each quarter.  This is because when you work with “financial advisors” or brokers, fees are hidden and reported as decrease in return.  In this way, “financial Advisors” can charge you fees no one would agree to if they knew.  This is how, not even the most honest, most genuine financial advisor could possibly serve the best interest of their clients.

If you’re new to ETFs, the simple way to explain them is to compare them to mutual funds.  A mutual fund manager is buying and selling stock throughout the year to try and beat an index, say the S&P 500, which is made up of the 500 largest companies in America.  History shows us that fund managers have a hard time doing this over the long term.  If you buy an ETF of the S&P 500, you are buying and holding all 500 companies in the index at usually at least 1% less than the mutual fund managers cost.   

So now that there are over 900 ETFs to choose from, covering everything from domestic large cap to frontier markets, it leaves one to wonder why these ETFs are not showing up in 401ks.  There are several hurdles that 401k providers have to overcome to have ETFs actually inside the 401k plan choices for a participant.  One of these is the trading of the ETF.  ETFs trade on exchanges just like stocks, so for each transaction there is a cost.  This trading cost can quickly erode returns and each transaction could cost as much as $15.  For a participant depositing $100 per paycheck into a 401k, this does not make sense.  Another issue is the automatic reinvestment of dividends.  ETFs do not trade in partial shares like mutual funds.  Additionally, for companies like Vanguard, there is really not any reason to offer ETFs in their 401k plans, as their offerings include their index mutual funds at virtually the same cost to the investors. 

The good news is that for all the other smaller 401k plans that Vanguard will not work with, these problems have been solved.  Companies like Wisdom Tree, Ishares, and a few other smaller players can now bring ETFs to a 401K plan, as well as traditional actively managed mutual funds.  Now the issue seems to be education.  In many cases, a company’s HR department is the gateway for 401k change.  Unfortunately, most HR people seem to be treating ETFs as some form of investing voodoo!  This is partially understandable with all the negative press surrounding inverse and leveraged ETFs.  If you take a closer look at leveraged and inverse ETFs, you will see that they only make up a small percentage of ETFs, are usually traded by professionals, and can be easily excluded from 401k plans.

The debate as to why ETFs should be in 401k plans could be argued on fund performance.  The active vs. passive debate has been covered a lot over the years.  The winner is usually a mix of both strategies, although in the interest of full disclosure, my firm uses a buy and hold global indexing approach to investing.  This keeps to our investing philosophy of maintaining a diversified portfolio, keeping cost low, and always investing for the long term.  Allowing index funds or ETFs into a 401k plan would certainly increase diversification and lower cost dramatically.

The cost of investing is something that is very hard for individual investors to follow.  The brokers gloss over the cost of investing.  Most that I have met don’t even understand that a mutual fund’s transaction fees aren’t included in the management or 12b-1 fee disclosures.  The average mutual fund costs 1.42%.  The average iShares ETF costs .41%.  The average index mutual fund costs .69%.  Since most 401ks have actively managed index mutual funds, in this cost comparison, there is a 1.01% difference in cost between ETFs and mutual funds.  If an investor had $20,000 in his or her retirement account and switched to an ETF portfolio, growing at 7% per year for 20 years, paying .50% in fees, the fund would grow to $70,500.  If the 401k participant used mutual funds at a fee of 1.5%, the money would only grow to $58,400.  This is a 17% difference!  Add in the fact that a University of Maryland study showed that only .06% of fund managers beat their assigned index from 1975 to 2007, performance is not even an issue; proper asset allocation and low fees are the key to success.

I don’t believe that rapid change is coming to 401k plans across America, but it could if employees understood what their real cost of investing is, and understood the power of global asset allocation indexing.  Certainly if Congress understood how insurance companies and America’s large financial companies are stealing from Main Street 401k plans, we might get change that we could invest in.

Until the day when indexing has its rightful place in 401k plans, there is a work around; a brokerage link.  Many 401k plans secretly have the ability to move a portion of a plan participant’s balance into a brokerage account.  Through this brokerage account, a participant can invest in individual stocks or… you guessed it… ETFs.  Buying individual stocks in your 401k is borderline reckless in my opinion; however a mix of large cap, mid cap, small cap, developed international, small cap international, emerging market, US bonds, US treasuries, international treasuries, and commodity indexes would be incredible.  I say brokerage links are secretly available because plan sponsors usually do not advertise this option. Why?  Most companies do not want their employees taking their retirement choices into their own hands.  I have met a few individuals that I would want to exclude as well, but in a free country, you’re fee to be stupid (or smart, as the case may be).  Another reason to do this is the low cost of ETFs.  A plan provider such as Merrill Lynch, Fidelity, or JP Morgan receives revenue from the mutual funds that are in the plan.  If a participant moves money to a brokerage link and purchases an ETF, the participant will pay a transaction fee to the plan provider; however if the participant uses a buy and hold strategy, the plan provider will not receive any more revenue.

I recently worked with the Atlantic Southeast Airlines Airline Pilots Association (ASA ALPA) on how to get more index mutual funds within the group’s 401k plan.  Despite the company’s fiduciary responsibility to look out for the best interest of the plan participants, the company continues to allow their plan provider, JP Morgan, to fill the 401k with proprietary funds like a Morgan Stanley mid cap that has not been in the top 50% of its peers in the last 5 years.  The company fails to understand the concept of indexing, asset allocation, and probably standard deviation and the Sharpe ratio as well.  These are things that someone who selects a 401k plan should know.  ASA  ALPA is in a unique situation in that the company wants a new pilot bidding system.  In return the pilots get a list of things, including a brokerage link.  Finally, the employees of ASA can buy and hold the ETF, thus saving them thousands in management fees.  Well and good, you would think, but JP Morgan has just put into place a new brokerage link policy that does not allow ETFs to be held in 401k plans.  Why?  Of course no rightly minded JP Morgan call center employee would go on the record, but let’s look at the facts.

In 2008, when billions were flowing out of mutual funds, ETFs saw record inflows, gaining assets from the mutual fund business.  There are over 900 ETFs on the market offering diversification in virtually any global asset class, many at less than 0.25% a year in fees.  Who loses here?  Well, besides the fund companies, plan providers such as JP Morgan will lose.  In this case I believe that the company (ASA) has the ability to say “Give it to us or we’re moving to one of the other providers (all of them) that do,” and the case will be closed.  The pilots have the ability to motivate the company to do this by simply stating, “No ETFs, no new bidding system.”  After all, we could be looking at a 17% difference in fund performance at retirement.  That is a pay raise they, and the rest of America, cannot afford to give up.

We have now come full circle here, and I believe that it all comes back to education.  An educated investor, armed with the understanding that no one is responsible for their financial freedom other than themselves, will be a successful investor.

Now go out, diversify, keep your cost low, and always invest for the long term.

Casey is the principal of Wiser Wealth Management, Inc., and has spoken around the world about ETFs and passive index investing, including the recent Inside ETF Conference in Boca Raton, FL.  He is also a pilot for Atlantic Southeast Airlines and works with ASA ALPA’s retirement committee but in no way represents the committee, ASA pilots, JP Morgan or the ASA, the company.  This article was written for www.ETFmarketpro.com.

What is your strategy and why do you use ETFs?

Matt, there are three ways to invest.  You can buy a stock, buy a mutual fund, or invest directly into indexes (ETFs).  The easiest way for me to explain this is if you purchased Coke stock and the evil people at Pepsi poisoned the Coke syrup, causing people around the world to die from Coke, your investment would be worth 0!  This is called company risk.  While everyone one tells you about their Google-type investment success story, many fail to mention the Enron type losses.  The next way to invest would be through a mutual fund.  While there are certainly some outstanding fund managers out there, the industry as a whole has had a hard time keeping up with the indexes over long periods of time.  If you hired a fund manager to pick your next cola investments, you are beting on his or her ability to avoid the Coke scenario I just mentioned.  A less expensive, more transparent, more liquid, and better diversified choice is investing directly into the index using an Exchange Traded Fund.  This is like buying all the cola companies out there, which greatly reduces your company and manager risk.  Our advisory fee plus the .25% cost of the ETF portfolio is over 1% cheaper than where you are today.  In real world terms, Wiser Wealth will purchases ETFs like the SPY that actually purchases all the companies in the S&P 500.  The same applies to TIPs, corporate bonds, small cap international, emerging market bonds, and stocks. 

Wiser builds portfolios using mostly ETFs like the ones I just described to access various types of indexes around the world.  Our core investing philosophy is to maintain a diversified portfolio, keep cost low, and always invest for the long term.  We consider ourselves passive indexers with a buy and hold strategy.  However, each year we review our models to see if there is a need for rebalancing.  While our overall strategy is to buy and hold long term healthy assets classes, we essentially rebuild our 4 main models each summer.  While most of the indexes and allocations remains intact, this forces us to look to see if there is access to new ETFs/indexes/asset classes that will help us achieve a portfolio’s objective.  We build our portfolios in two ways.  Our aggressive model strives to achieve the maximum amount of gain for the least amount of risk.  All other models, such as conservative through moderate, strive to achieve the maximum amount of gain for a given amount of risk.  Here are some examples……………. Let’s compare the cost and performance of these models to where you are now. 

What are the risks of ETFs that you’re not telling me about?  What could go wrong? 

The ETFs that we trade in are large, proven investments that have been around for a long time.  There are ETFs that use leverage or investing formulas that are not very clear.  These ETFs have additional risks.  We do use a commodity ETN that gives you the returns of a commodity index; however, you do not actually own any commodities.  What you own is a promise to pay the index’s returns.  Should the provider go out of business, you could lose your investment in that ETN.  We monitor the financial health of the issuer in this case.  For example, when Lehman began having issues, we looked closely at the health of Barclays. 

Why not use index mutual funds?

Wiser uses a complete indexing approach.  We do not seek out actively managed mutual funds, as they generally are more expensive than indexing.  We do not believe that timing the market has proven successful.  There are index mutual funds that work for individual investors, but at our custodian, trading an ETF costs half as much as trading an index mutual fund.  Index mutual funds do have some tax disadvantages compared to ETFs and, for the individual investor, index mutual funds are more expensive.

I’ve heard commodity ETFs don’t actually deliver the spot returns you expect.  Why is that?

The way commodities get represented in commodity indexes and inside ETFs are typically through rolling futures contracts.  Returns from these contracts come from the change in the expected future price of the commodity; this price is very different from the actual price of the commodity that can be bought today, which is the spot price. 

Many investors were surprised this year when the oil fund they thought was tracking oil prices was actually tracking the expected future price of oil. 

Why should I pay an advisor to manage a passive investment strategy?  Can’t I do it myself?

For many investors, asset allocation is built on feeling rather than using standard deviation, the Sharpe ratio, and other types of risk measuring tools.  Will you rebalance your portfolio on your own?  Will you be able to understand economic events and how to adjust the portfolio accordingly?  Do you ever have tax questions or estate planning questions?  Our AUM fee covers not just portfolio management, but also tax and estate planning.  These are the questions that I would ask a do-it-yourself investor.  You have to take the emotion out of investing.  Many individuals have a hard time doing this, which is why at my firm, we manage by committee.

If you really want to invest on your own through a company like Vanguard, you do have the option to hire us by the hour.  However, it is usually cheaper to become a full service cleint.

How do you ensure you get good trade executions? 

Most trades at Wiser Wealth are done through batch trades.  Batch trades allows us to pull all the investors’ trades together.  We then set limit prices on the ETF buys and sells.  Our limit prices are based on the NAV of the ETF at that moment of trading.  A simple way to get the real time NAV is through Yahoo finance.  Just add ^iv to most ETF symbols.  A Bloomberg terminal is the other way to get NAV.

What about currency?

We do not invest in currency as an asset class, but some of our indexes, like IGOV and EFA, have benefited from a falling dollar.  Last summer, we added TIPS to the portfolio while they were cheap, as no one was talking about inflation.  Currency ETFs are trading on currency futures, not actually buying the foreign currency.  This has additional risk in an abnormal market.  Long term investing in currency is not somehting that we see as healthy at this time.

I read about all the blowups in the leveraged ETFs.  How do I know who to trust?  Would you use leverage ETFs in your account?  What’s wrong with them anyway? 

There is nothing wrong with leveraged ETFs IF you understand them.  We do not use leveraged ETFs.

I just don’t want my portfolio to go down 50%.  What can you do to help me?

For all our models other than the aggressive model, a loss of that magnitude is virtually impossible.  However, if losses are not an option, we can employ an option strategy on the S&P 500 to add income and create short term insurance on a portion of the portfolio. 

Should I buy an ETN?

Yes, but carefully and probably only for commodity exposure.

I’ve read that you can only buy ETFs with $100 million in assets.  Is that true?

That is a good point, but there are 250 ETFs with less than $20 million in assets.  You can buy them, but if not traded carefully, you may end up purchasing at a premium.  Only one of our ETFs, IGOV, approaches that asset level, with $134M in assets.  We noticed when we added IGOV during our last rebalance that it took much longer to purchase at our limit price near the NAV vs. the quick trade at market.  The performance has been just fine, it just took a few extra hours to move the trade through.  Should it have taken longer, we would have simply called the TD Ameritrade trading desk to call the exchange to get the trade processed.