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Active Managers Strike Back – But Are They Worth It?

Active management is finally beating the S&P for a quarter – by 1%. Nonetheless, you will not hear the end of it as they fill the MSM with positive stories. We do the math because, maybe, you can do a lot better on your own. (click to enlarge) Active managers finally had a good quarter. As you can see from the chart, it was kind of a pathetic quarter with actively managed funds (who research U.S. stocks before they buy or sell, as opposed to ETFs or other passive funds) outperforming by about 1%. But it’s the first time stock pickers beat the benchmarks since 2013, so you’re going to hear a lot of crowing about it this week. And active managers can afford to crow because they charge you massive fees for that 1% outperformance (once every few years and following last year’s 7% underperformance), so they’ve got lots of money for PR and advertising and that’s why, this week, you’ll be hearing the words ” Active Management ” mentioned over and over again in the MSM, who are very happy to tout the benefits of anything that pays them money. (click to enlarge) I’m not against active management per se – we teach our PSW Members to be active managers of their own portfolios. I’m not fan of ETFs either as you end up buying the bad with the good – I’m simply pointing out that this small, 1% outperformance in one Q of one year should not be used to convince you that active managers have a clue. NO ONE has a clue as to where to invest your money that’s better than your own ideas (assuming you are educated enough to be reading and understanding this in the first place). The TREMENDOUS advantage you have when you learn to invest your own money is that you’re not charging yourself fees. It’s not the performance of active management that kills you – IT’S THE FEES. Even at “just” 1%, over 50 years of investing your active manager is taking 50% of your total account. Unless his long-term outperformance is better than 1% per year, YOU WILL LOSE MONEY WITH ACTIVE MANAGERS. YOU are the best person to invest your own money and our goal is to teach you that it’s not hard to do that. At the base level, you should start by investing in things you know well. When I was seven-years-old (1970), my grandfather told me the same thing and asked me what stock I wanted to invest in and I said ” Cadbury ” because I loved the chocolates (he lived in England). He bought some for me and that became my first stock. When I got older and began investing my own money, I bought tech companies because I was into tech in the 80s. That was very fortunate, of course, because I caught the boom but was it fortunate or was it smart to buy the kind of stuff recent college graduates (me) were into? Intel (NASDAQ: INTC ) seemed like the most obvious stock in the world to me in 1985, as did Apple (NASDAQ: AAPL ). I didn’t need a hedge fund manager to charge me 2/20 for that advice, did I? (click to enlarge) That, by the way, is another thing that doesn’t occur to investors – you don’t NEED to give ALL your money to an active manager. If you have $1M worth of AAPL and $1M worth of IBM and $1M worth of Wal-Mart (NYSE: WMT ) and intend to hold them long-term – why do you need to pay your manager $30,000 a year to hold them for you? If it’s a $10M portfolio, keep your own major positions and let them play with the rest but $30,000 a year over 20 years is $600,000 to hold $3M worth of stock for you – THAT IS A BAD INVESTMENT! I’m going to repeat this because it’s VERY IMPORTANT that you understand this: If you have more than $1M, it pays you to take an active role in your own investing. Aside from the fact that fund/management fees destroy your portfolio’s value over time, managing your own portfolio is a job you can easily handle. Let’s say you have an active manager who matches the S&P over 30 years at 8.5% but he takes a 1% fee – that’s 7.5% to you, right? Compounding just $1M for 30 years at 8.5% nets you back $11,558,251 but giving back JUST 1% of that money to an adviser every year drops your net to $8,754,955 ( play with the numbers here ) – that’s $2.8M you end up paying your ” friendly ” active manager – close to $100,000 per year on the average AND 280% of what you started with. That 1% number is very tricky, isn’t it? Over the course of 30 years, at 8.5% annual growth, you make $7.75M while your manager makes $2.8M. This would be fine if he were beating the S&P for you consistently but, if not – what on Earth are you doing in this relationship? Again, you don’t need to go cold turkey but simply consider taking half of your money out (saving you $1.4M in fees) and investing it yourself in LONG-TERM, CONSERVATIVE strategies . For example, we found two trade ideas on Friday we’ll be adding to the LTP that will go in this week (we didn’t have time on Friday). Those trade ideas were: Chimera (NYSE: CIM ) – Maybe we need to add them back too. Let’s pick up 1,000 for the LTP at $14.63 and sell the Dec $14 calls for 0.85 (no less) and the $14 puts for 0.80 as we REALLY would like to end up with 2,000 since they pay a $1.92 dividend. We may get called away at $14 but that’s OK as our net is $12.98 so, if called away, we just have the short $14 puts and $14 back in our pocket. If not called away, the dividend is 15.2%! (click to enlarge) I’m thinking Sotheby’s (NYSE: BID ) should do well with all this crazy art auction money being spent. (click to enlarge) Would have been nice to think of it earlier but no reason not to sell five 2017 $37 puts for $3 in the LTP, just to keep an eye on them (and get another $1,500 in cash). They only made $117M last year on $1Bn in revenues and Christie’s just had a $2Bn auction so it’s no stretch to imagine Sotheby’s will also have some huge auctions and collect blow-out fees as well. If you’re not used to options trading, you may want to join an educational site that teaches you the finer points of trading before making investments like these but consider the idea of investing that 1% per year in yourself – not in having someone else manage your money – keeping you dependent on them FOREVER! Keep in mind an index ETF like SPY, which has just a 0.09% expense ratio will, by definition, match the S&P’s performance (and pay a 1.89% dividend) pretty much exactly. That’s another huge factor in considering whether or not your active manager is worth a damn. Over the past three years (since 12/31/2011), SPY has gone from $125.50 to $212.44 – that’s up 86.94% in three years. Is your ” active ” man ager doing that for you? Not only that, but SPY has paid 13 dividend checks of about 0.80 each for another $10.40 (8.2%) so, if you had $100,000 on Dec 31st 2011 and just put it in SPY, you’d now have $195,140 – almost double in three years. If the guy you are giving your money to isn’t doing that well for you – consider the possibility that you can do better on your own – even if you just dump it all into SPY, which is the most passive investment you can make. Worth considering? Disclosure: The author is long CIM, BID. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Positions as indicated but subject to RAPIDLY change (fairly bearish mix of long and short positions – see previous posts for other trade ideas). Positions mentioned here have been previously discussed at www.Philstockworld.com – a Membership site teaching winning stock, options & futures trading, portfolio management skills and income-producing strategies to investors like you.

Sell The State, Buy The People

Summary State-owned companies dominate many emerging-market ETFs. State-owned companies generate lower return on assets than privately-managed firms. Avoiding the slower-growing state firms by going with small caps, or a fund such as XSOE. Investors can slice and dice the investment world into all manner of categories. One of the most common is to separate its investments into domestic and international, developed and emerging markets, then into regions or individual countries. A different way to slice the market is to break it down into state-owned and private companies. This is not a critical distinction for investors in the developed world, where deep capital markets offer exposure to many private firms, but many emerging markets are still developing their capital markets. A passive investment approach in emerging markets results in a state-owned heavy portfolio, but there are ways to avoid this exposure. State Interference Doesn’t Pay At least since Ludwig Von Mises published Economic Calculation in the Socialist Commonwealth , the case against socialist economic planning has been there for those who choose to look. Without information, an enterprise cannot make good decisions, and one of the first casualties of central planning is the informational content in prices. Prices exist in centrally-planned economies, but they do not reflect the supply and demand in the economy. The unfolding disaster in Venezuela, a country that suffered toilet paper shortages and is now occupying supermarkets with the army in its never-ending war against the laws of economics, is only the latest example of this basic truth. Clearly, one does not want to invest in a basket case such as Venezuela. At the other end, one cannot avoid some intervention in the economy, as nearly every nation on Earth has a central bank working to manipulate interest rates. In between are the mixed economies such as in China, where the transition to market capitalism is still incomplete. These countries have varying degrees of market forces, but one common trait in many is that state-owned enterprises (SOEs) compete alongside private firms. In many of those countries, the state-owned giants dominate the stock market and make up the bulk of market capitalization. The extreme case is China, where most of the listed companies on the mainland stock exchange are SOEs. In Brazil, semi-private Petrobras (NYSE: PBR ) has accounted for 20 percent of stock market capitalization alone. As oil prices have tumbled and PBR sees corruption charges swirl around the firm , investors in funds such as iShares MSCI Brazil (NYSEARCA: EWZ ) have paid the price. Investors who passively plunk money into market capitalization index funds are often unknowingly choosing to invest with the state and even where the firms are increasingly competitive, they still often lag behind fully-privatized competitors. Recent figures show that Chinese SOEs earn about 5 percent on assets , versus roughly 9 percent for private firms. SOEs in China achieve this low return despite access to cheap credit and regulatory favoritism, in part because the largest shareowner, the state, cares about many things besides profit. Additionally, the government officials in charge of these firms have their own private agendas, and those often stray into the realm of corruption. Some recent examples are the lackluster performance of Russian energy firms even when oil prices were high, Chinese banks that have run up a mountain of bad debt due to politically-motivated lending, and as mentioned above, Brazil’s largest company is racked with scandal. Aside from the aforementioned issues, there’s the issue of sector exposure. Many state-owned companies are banks, energy producers, utilities and telecom firms. While these companies can experience rapid growth in a rapidly-growing economy, they aren’t growing as fast as technology start-ups and new consumer companies catering to an emerging and increasingly wealthy middle class. Investment Options There are some ways around this, the easiest of which is to go with small caps, though that involves taking on more volatility. Broad small-cap ETFs, such as WisdomTree Emerging Markets SmallCap Dividend (NYSEARCA: DGS ), reduce exposure to SOEs. Guggenheim China Small Cap (NYSEARCA: HAO ) and Market Vectors Brazil Small Cap (NYSEARCA: BRF ) both offer a different mix of sector exposure along with avoiding the giant SOEs that populate many emerging-market ETFs. Some sector ETFs, such as KraneShares CSI China Internet (NASDAQ: KWEB ) achieve the same result. WisdomTree Emerging Markets ex-State-Owned Enterprises (NYSEARCA: XSOE ) WisdomTree launched XOSE in December to help investors maintain emerging market exposure while avoiding state-owned companies. The case for the fund is straightforward: the growth of emerging markets is the story of a rising middle class. The sectors most poised to benefit are those that serve these customers: consumer staples, consumer discretionary and healthcare firms. Technology is also an emerging sector in many of these countries that is growing far faster than the overall economy. To really profit from the growth of emerging markets, investors want to be positioned in the sectors pulling GDP forward, not the moribund state-owned enterprises that lag behind or at best, are indirect plays on the commodity cycle. From WisdomTree’s website : (click to enlarge) Technology is the largest sector exposure at nearly 23 percent of assets. Healthcare is underweight, consumer discretionary and consumer staples are the third and fourth largest sectors. Financials are a large portion of assets at about 20 percent, but that is less than many emerging market funds. One reason why the fund isn’t better positioned with respect to sectors is because the fund’s main goal is the removal of SOEs, not a shift in sector exposure. From WisdomTree, the index criteria (emphasis mine): ” State owned enterprises are defined as government ownership of more than 20% of outstanding shares of companies. The index employs a modified float-adjusted market capitalization weighting process to target the weights of countries in the universe prior to the removal of state owned enterprises while also limiting sector deviations to 3% of the starting universe. ” For investors who want to remove SOE exposure while still getting similar sector and country exposure as the run-of-the-mill emerging-market fund, XSOE is a great choice. Assuming the state-owned companies aren’t reformed and unlock hidden value from their assets, over time XSOE should beat the market capitalization weighted competition such as iShares MSCI Emerging Markets (NYSEARCA: EEM ). The case for owning XSOE over other funds is stronger today because the sectors dominated by SOEs are at the center of the slowdown in emerging markets, from China’s debt-laded banks to Brazil and Russia’s energy-heavy stock markets. The fund might lag for long periods when plain vanilla emerging market funds benefit from the sector exposure that SOEs bring, but over the long run, XSOE is likely to come out ahead thanks to holding shares in more efficient firms. 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.

Investing In Africa With ETFs

ETFs have penetrated niche asset classes, such as frontier markets equity. This includes Africa, with EZA, AFK, and NGE. In illiquid, under-researched markets, ETFs don’t offer the same diversification and market return matching as in the US. Particularly in Africa, ETFs may not be adequate as a replacement for individual securities but can serve to gain additional diversification. Case in point: the Nigeria focused ETF NGE. Is there an app for that? A few years ago that was a fun and only slightly rhetorical question, as we traded in our flip phones for smart phones and our PCs were catching flak from the tablet takeover. Today no one asks, because he answer is unequivocally “yes.” In similar fashion, a present day investor might ask: is there an ETF for that? Increasingly, that is a rhetorical question as well. Mostly, that is a good thing. Exchange Traded Funds (ETFs) have leveled the playing field by democratizing access to asset classes and markets traditionally only accessible to sophisticated investors such as endowments and pension funds. But if ETFs sometimes sound too good to be true, it is because they are. Where they excel is in traditional asset classes where a passive, low-cost basket of stocks is generally a better alternative to an actively managed, less transparent, less tax efficient portfolio. The risk lies in the fact that ETFs are not a cure for illiquidity, market inefficiency, and increased correlation between asset classes. As investors in Africa we at Africa Capital Group have looked at several ETFs including iShares MSCI South Africa (NYSEARCA: EZA ), Market Vectors Africa (NYSEARCA: AFK ), and Global X MSCI Nigeria (NYSEARCA: NGE ). I wanted to focus particular attention on NGE, because investors are well served to take a careful look under the hood. If investing in Nigeria were as simple as equating high GDP growth rates and favorable demographics to a rising tide that lifts all stocks, than NGE would be your fund. The reality however, is more complex: 1) NGE is not that diversified. The top holding, Nigerian Breweries, comprises nearly 20% of the fund and the top 10 names comprise nearly 75%. 2) Almost 50% of the fund is invested in banks. Granted, the financial sector plays an outsized role in the economy relative to developed market, but still, 50% is a lot. 3) Illiquidity + Illiquidity ≠ Liquidity. Just by wrapping Nigerian stocks in a crisp US-traded ETF you have not solved the illiquidity problem of the underlying securities. As long as demand and supply for the ETF shares is relatively balanced, the ETF’s share price should be able to stay close to its NAV. However, that does not mean that the NAV can’t be dragged down by investors outside of the ETF demanding liquidity in the market place during a downturn. Furthermore, if US investors on their own decide to dump NGE in some sort of a risk-off frenzy, than the ETF might be forced to sell shares of the underlying securities, thus demanding liquidity in the Nigerian market, which will come at a cost. 4) My last point, and the one I feel strongest about, is that sub-Saharan Africa might actually be one of the few places on Earth where active, bottom-up investing still makes sense. You cannot sit in an office in New York with a Bloomberg terminal and know everything you need to know about Africa. It takes traveling there, to appreciate that Africa is not a uniform place of war, poverty, and disease. Information flow is light, research is scarce, and liquidity is low in all but the biggest names. In other words: ideal circumstances for “boots on the ground” and active management. An ETF approach to these markets will not capitalize on the advantage that can be had by discriminating between stocks with good prospects and those without. In summary, I am a believer in ETFs, but I am less convinced that they can be used as a one-stop-shop to gain access to African stocks. Perhaps they can be added to a portfolio of individual stocks for further diversification, but, in my view, they do not suffice as a standalone solution. Disclosure: The author is long EZA. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.