Friday, November 26, 2010

Investor Behavior More Important Than Investment Performance

Nick Murray / November 25, 2010 / Originally published on
... There is no statistical evidence for the persistence of performance. And, at huge market turning points, relative performance – in addition to being unpredictable and uncontrollable – simply doesn’t matter.

What, then, can an investment advisor offer that is manifestly worth multiples of what he charges, again and again over a client’s investing lifetime? Why, of course: it’s behavior modification.
The dominant determinant of long-term, real-life financial outcomes isn’t investment performance. It’s investor behavior. And the most high-value service we can offer is preventing the client from behaviorally blowing himself up...
...the behavioral value proposition. It doesn’t always work that quickly or that dramatically. But, human nature being what it is, it always works.

Friday, November 19, 2010

Outside the Flags: Weather vs Climate

Jim Parker, Vice President, DFA Australia Limited

Notice how TV stations put finance next to the weather report on the evening news? In each, talking heads point at charts and intone about stuff that in most cases will be quickly forgotten. In the meantime, the long-term story gets lost.

It's an old tradition, but a certain segment of the investing population tends to feel that they aren't sufficiently informed about the financial world unless they have checked daily or hourly on how the Dow, FTSE, Nikkei or All Ordinaries have moved in the intervening period.

It's a pretty harmless activity in most cases. It at least provides a bland conversation starter in fleeting social encounters, just as keeping up to date with tomorrow's weather forecasts can fill an awkward silence.

But our very human focus on the day-to-day and the short term can often encourage us to make bad decisions that affect our long-term interests.

Here's an example: On October 30, 2009, The Australian Financial Review led its markets section with the headline 'Shares Slide on Fears for US Housing'. The Australian equity market had suffered its largest one-day fall in more than four months after unexpected news of a slowdown in the US housing market.

Now, an investor who closely scrutinizes the daily market reports may have taken fright at this story and informed their financial advisor that they were not convinced the global economic recovery had traction and they wanted out.

But the very next day, the story had changed completely. The same newspaper led with the headline 'US Growth Spurt Puts Market Back on Track'. In this case, the US Commerce Department had reported stronger-than-expected economic growth figures which had helped ignite a marked reversal in sentiment.

Our plugged-in investor might have changed his mind at this news and told his advisor to ignore what he had said the day before.

But wait! There's more. Another day passed and this time The Australian Financial Review splashed with 'More Bad News on the Way'. A renewed fall on Wall Street on the back of news of a decline in consumer spending had local markets primed for another bad day.

And on it goes. From day to day to day, market sentiment shifts in reaction to news—news about the economy, news about companies, news about governments and politics and the wider world. Prices rise and prices fall in response to this news, which by definition is unpredictable.

Think of it like the weather. One day it's sunny. The next day it rains. It's unseasonably warm one day and uncharacteristically cool the next.
*ASX-500 Accumulation Index, Jan 1980-Oct 2010; Source: Returns Program
What can you do about it? Well, in the case of unpredictable weather, you can ensure you're equipped for all conditions—an umbrella, a raincoat and some sunscreen in your bag just in case.

Likewise, in the case of investment, you can stay diversified. That means you don't have all your money in one type of asset—like just property for instance or just shares or everything in cash. You need a mix in your portfolio so it can withstand a range of outcomes and keep you in line to meet your goals.

The nightly news is interesting, undoubtedly. But it's like the difference between the weather and the climate. One changes constantly; the other more gradually and imperceptibly. With investment, it's the climate you need to think about.

*ASX-500 Accumulation Index, Jan 1980-Oct 2010; Source: Returns Program*ASX-500 Accumulation Index, Jan 1980-Oct 2010; Source: Returns Program

Friday, November 12, 2010

Cycles of Life - A Cycling Documentary

Sweet short film by 16-year-old Johannes Bay from Christchurch, New Zealand.

2010 Nobel Prize in Economics

..or its correct title: The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel

Press Release

11 October 2010
The Royal Swedish Academy of Sciences has decided to award The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2010 to
Peter A. Diamond
Massachusetts Institute of Technology, Cambridge, MA, USA,

Dale T. Mortensen
Northwestern University, Evanston, IL, USA
Christopher A. Pissarides
London School of Economics and Political Science, UK
"for their analysis of markets with search frictions"

Markets with search costs

Why are so many people unemployed at the same time that there are a large number of job openings? How can economic policy affect unemployment? This year's Laureates have developed a theory which can be used to answer these questions. This theory is also applicable to markets other than the labor market.
On many markets, buyers and sellers do not always make contact with one another immediately. This concerns, for example, employers who are looking for employees and workers who are trying to find jobs. Since the search process requires time and resources, it creates frictions in the market. On such search markets, the demands of some buyers will not be met, while some sellers cannot sell as much as they would wish. Simultaneously, there are both job vacancies and unemployment on the labor market.
This year's three Laureates have formulated a theoretical framework for search markets. Peter Diamond has analyzed the foundations of search markets. Dale Mortensen and Christopher Pissarides have expanded the theory and have applied it to the labor market. The Laureates' models help us understand the ways in which unemployment, job vacancies, and wages are affected by regulation and economic policy. This may refer to benefit levels in unemployment insurance or rules in regard to hiring and firing. One conclusion is that more generous unemployment benefits give rise to higher unemployment and longer search times.
Search theory has been applied to many other areas in addition to the labor market. This includes, in particular, the housing market. The number of homes for sale varies over time, as does the time it takes for a house to find a buyer and the parties to agree on the price. Search theory has also been used to study questions related to monetary theory, public economics, financial economics, regional economics, and family economics.

Peter A. Diamond, US citizen. Born 1940 in New York City, NY, USA. Ph.D. 1963, Institute Professor and Professor of Economics, all at Massachusetts Institute of Technology (MIT), Cambridge, MA, USA.
Dale T. Mortensen, US citizen. Born 1939 in Enterprise, OR, USA. Ph.D. 1967 from Carnegie Mellon University, Pittsburgh, PA, USA. Ida C. Cook Professor of Economics at Northwestern University, Evanston, IL, USA.
Christopher A. Pissarides, British and Cypriot citizen. Born 1948 in Nicosia, Cyprus. Ph.D. 1973, Professor of Economics and Norman Sosnow Chair in Economics, all at London School of Economics and Political Science, UK.

Saturday, November 06, 2010

The Economics of Fiscal Deficits

I attended this presentation, by Marlena Lee, at Dimensional's office in Sydney in October. She uses historical data to make some really good points that are often missed by mainstream financial media, with there short-term focus and constant search for a narrative to explain recent events and market movements:
Many investors are concerned that rising government debt will stunt economic growth and hamper market returns. Marlena Lee examines historical data to test the relationships between fiscal deficits, interest rates, business activity, investment returns, and exchange rates. Her conclusions may surprise investors who are pessimistic about future market performance.

Friday, November 05, 2010

The Money Merry-Go-Round

by Carl Richards at

Think about the most recent discussion you had about money. How closely did it match the next most recent money conversation? Without realizing it, we engage in conversation after conversation about money that ends up talking around it....
Like religion and politics, money sits in a place that makes us squirm when discussed...
Access to information and the ability to share it easily has made discussing money in our families, in our communities, and in society at large more acceptable. There is also a growing recognition among real financial professionals that great discussions about money are really great discussions about life. In order to make good financial decisions we have to make them in the context of our lives...

Friday, October 29, 2010

Seduced By Complexity

From Behavior Gap Newsletter, Thursday 28 October:
Why do we say we want simplicity and then chose complexity? It often starts when we get caught in the trap of two competing stories. In the first one, we tell ourselves we want to simplify, simplify, simplify. In the second story, we tell ourselves that the solution to an important problem has to be complex. The reality is that getting something simplified is the ultimate form of sophistication, so why don’t we choose simplicity when it comes to financial planning? ...
... I’ve seen people disappointed when I’ve proposed a simple solution to their investment or financial planning problems. Often the solution can be reduced to a simple calculation on the back of a napkin, but clients somehow take comfort from a 100-page paperweight packed with a thousand calculations. Logically they know that complexity isn’t a guarantee, but it seems to make people happy.
Behavior Gap is a registered trademark of Carl Richards.

Tuesday, October 26, 2010

Outside the Flags: The Rate Show

Jim Parker, Vice President, DFA Australia Limited

Any financial editor knows interest rate forecasts always make popular articles. After all, so many people are sensitive to rates either as lenders or borrowers. If only they knew they don’t need a forecast to invest wisely.

With forecasting economists seeking publicity and the media wanting easy cut-and-paste coverage that keeps readers clicking through to see the ads, it’s easy to understand the demand for stories speculating on rate movements.

But what’s not often appreciated by the general public is that the wholesale bond market is usually two to three steps ahead of the official forecasters in pricing in expectations for what the central bank might do.

In viewing this phenomenon in action, Australia is a good example because the Reserve Bank here has moved ahead of the rest of the world in slowly moving up official cash rates from crisis levels closer to long-term averages.

The chart below compares benchmark short-term lending rates in Australia, the UK, Canada, the Euro area, Japan and the US over the last six years. As you can see, while rates in the other major developed economies have remained at 1 percent or lower, Australia’s cash rates have moved up from 3 to above 4 percent since late 2009 due to the relative strength of its economy.


While the RBA kept its cash rate on hold throughout the June quarter after the last move in May, newspapers at time of writing were full of speculation about a possible resumption in this policy tightening program in November.

This speculation is good for circulation as it gives people the perception that by closely tracking the views of the market experts, they can manage their portfolios in a way to avoid the impact of the rate increases when they come.

The problem for the general audience is that all that information and commentary and analysis from the bank economists tends to be already reflected in prices. In other words, by the time you read about it, it’s old news for the market.

And even if you did get the “inside word” on anticipated interest rate moves, there is no guarantee that new events will not occur in the meantime to change the outlook yet again and leave your timing strategy in tatters.

Take, for instance, what happened in Australia in early October. The RBA took the market “by surprise” in not announcing a rate increase after its monthly policy meeting. The move had been seen as such a sure thing that one major national newspaper had the story pre-written and published on its website that the rate rise had, in fact, happened when it, in fact, hadn’t.1

The story quickly disappeared when an alert editor noticed the central bank’s website actually said rates had not changed, but some astute blogger was clever enough to take a screenshot before the evidence could be removed.

In late October, the Reserve Bank published minutes of that meeting, revealing that the decision had been “finely balanced”, but that the sudden surge in the Australian dollar in early October had been one consideration in waiting.2

Financial markets then began to speculate again on the likely next move. This chart of implied yields on 30-interbank cash rate futures – a proxy for official cash rate expectations – shows that as of late October the market was already priced for at least two further quarter percentage point rate rises over the coming year.


This is not to suggest these priced-in increases are a done deal. But it serves to highlight that markets move very quickly in anticipating interest rate changes. Naturally, as new information comes to light, that pricing may change.

But the important point for the small investor is that the noise around interest rates in the media usually reflects expectations that are already in the price. It is incredibly difficult, without inside information, to second guess the market and forecast interest rate movements with any sustained accuracy.

This is why Dimensional does not try to play the forecasting game. Instead, it works with the opportunities in the yield curve as they present themselves day to day. When there is an opportunity for taking on more term risk (longer-dated bonds), the portfolio managers will do so. But when the yield curve is inverted (short-term interest rates are higher than longer term), they will move the strategies closer toward cash.

This is not a market timing approach. It is about taking on more term risk when there is an acceptable reward for doing so and winding back on term risk when expected returns from that risk factor are not so great.

In Dimensional’s newer US fixed interest strategies, it takes a similarly variable approach to credit risk, adopting greater risk when expected returns from lower-rated investment credits are high and winding back when anticipated rewards are low. As always, risk is controlled by very broad diversification.

So the bad news about interest rates and fixed interest investing is that there is no such thing as a crystal ball that works. The good news is that you don’t need one to invest successfully in this asset class.

1. Reserve Bank Lifts Interest Rates to 4.75pc, The Australian, Oct 5, 2010

2. Minutes of the Monetary Policy Meeting of the Reserve Bank of Australia Board, Oct 5, 2010

Thursday, October 21, 2010

Golden Opportunity in Stocks? -

As investors make the flight to safety, are they missing a golden opportunity in stocks? Jeremy Siegel, a professor of finance at Wharton, shares his view:

Golden Opportunity in Stocks? -

Tuesday, October 12, 2010

Things You Should Focus On

Overconfidence is a huge problem when it comes to making investment decisions. In fact, it’s a huge problem when we’re dealing with any issue that has an unknown outcome. It’s clear that we’re very bad at dealing with unknown outcomes...


Thank you Carl Richards. See more and purchase prints at BEHAVIORGAP.COM

Friday, October 08, 2010

Professional Help*

Not surprisingly, the percentage of self-managed super funds seeking investment advice fell in the immediate wake of the global financial crisis.

When investors are disappointed with their returns, many typically think they can do a better job by themselves – although logic would suggest that when returns are suffering, quality professional advice is even more needed.

Now with stronger investment markets, more SMSF trustees are beginning to turn back to financial planners.

The 2010 SMSF Investor Report, released this week by specialist investment researcher Investment Trends, reports that more than 65% oSMSFs gained investment advice over the past 12 months – up rather modestly at this point from 61% i2009.

This advice was from a range of specialist financial planners, accountants, full-service brokers, specialist super consultants and private bankers – all with the appropriate ASIC qualification to provide investment advice. And by far, specialist financial planners gave the largest proportion of the advice.

The particularly interesting percentages provided by Investment Trends are that back in 2007, before the GFC, 71% oSMSFs gained professional investment advice, and this percentage had fallen sharply to 61% blast year. So there is still quite a bit of ground for advisers to recover.

According to the report, just 10% oSMSFs seek investment advice because the trustees are “uncomfortable making their own investment decisions”. Many more seek advice to get a second opinion, gain access to a wider range of investments and to gain access to an adviser’s technical skills.

Clearly, a challenge for advisers in the future is to convince SMSF trustees, and other investors for that matter, that their services are needed throughout all market conditions – good and bad.

* Written by Robin Bowerman, Head of Retail at Vanguard Investments Australia.
To receive this column by email each week, register with Smart Investing™.

Tuesday, September 28, 2010

"It is the same stupid old normal we've always had."

From AAP in September 28, 2010 - 11:41AM

Crisis on repeat: We're chimps with no memory

Fisher Investments chief executive Ken Fisher says the economic conditions facing the world today are not dissimilar to previous downturns, like that seen in the early 1990s.

"If you read the media from 1991 it sounds just like it does today," he told the Forbes CEO Conference today.

"We're chimpanzees with no memory.

"Our problems in this environment, that we think are so unique, so abnormal.

"It is the same stupid old normal we've always had."

"We keep chewing the cud. We go over the same stupid wrong pessimistic stories... ruminating on them again and again."

Mr Fisher said unlike five out of six US investors, who "believe we are going sideways or going down", he was bullish about the future.

"I believe the next 10 years will be just as good as the 1990s," he said.

"In my mind, I think the period we have ahead of us is as good as we have ever had ahead of us, at a time when people believe we have a lackluster world ahead at best."


Wednesday, September 22, 2010

Smart thinking trumps crystal ball

Good piece by Tim Blue in today's Australian:

IT is track record through time that can be most telling with fund managers.

Watch them ride out market cycles through smart thinking and investment processes robust enough to withstand the roller-coasters of financial crises.

Texas-based Dimensional Fund Advisors focuses on value and small capitalisation stocks, and deals with them in a way that eschews both index-style and traditionally active trading.

Its Australian Value Trust boasts a 10-year track record of 11.5 per cent annualised to August this year, net of fees, well ahead of the S&P/ASX 200 accumulation index of 7.3 per cent for the same period...


Tuesday, September 21, 2010

Classic YouTube

From Matthew Price's Broom Wagon at SBS Cycling Central

Before Mark Cavendish's win at Salamanca on Thursday there was Adriano Baffi, who won the same stage of the 1994 Vuelta at the considerable expense of Mercatone Uno team-mate Mario Cipollini. Despite not wearing a helmet, the future Lion King somehow escaped serious injury.

Wednesday, September 15, 2010

See the faces of the Pakistan floods: An unforgettable video

TED’s curator, Chris Anderson, was born in Pakistan, and feels an enduring tie to the country — which has recently experienced the worst floods in living memory, killing thousands and displacing tens of millions of people. Chris and his wife, Jacqueline Novogratz of the Acumen Fund, traveled the country, visiting camps and flooded cities — and gathering personal stories from this massive disaster (read them on Chris’ personal blog).

Tuesday, September 14, 2010

The Investment Answer

Excellent new book by Dan Goldie and Gordon Murray is available to buy or download for free in pdf format at:

About the Book (from

This unique book is written in clear and understandable language. Whether you are new to finance or an experienced investor, this book is essential reading. It cuts through the Wall Street hype to give you just what you need to know. You will learn to take advantage of how markets really work and how to benefit from the wisdom that Nobel Prize winners have acquired over the last 60 years. This book will change the way you think about investing.

About Daniel C. Goldie, CFA, CFP

Mr. Goldie is President of Dan Goldie Financial Services LLC, a registered investment advisory firm that helps individual investors and families manage their money and make smart financial decisions. He has been recognized by the San Francisco Business Times as one of the top 25 Bay Area independent advisors, and by Barron's as one of the top 100 independent financial advisors in the United States.

Tuesday, September 07, 2010

Should we Still be Worried? ... I Say No

I am optimistic about markets going forward. I went to a good presentation last week on sovereign debt issues and impacts on global markets.

The fact is that, so long as we assume that markets are relatively efficient, all of the issues that may give cause for alarm are already factored into prices today. When you buy a share in a company today you are buying an entitlement to a share in all of the future earnings of that company and the price that you pay is the best estimate of those future earnings, discounted back to today's value. If company earnings are likely to be lower in the future then today's price of the company's shares is lower.

The expected return, even from US shares, going forward from today is very similar to that you should expect from Australian shares. At first this may seem counter-intuitive but with the free-flow of capital and efficient markets then if higher returns could reasonably be expected from say Australian markets than US markets then global hedge-fund managers would be selling US shares today and buying Australian shares. Prices would immediately adjust until the expected future returns were similar (ie. Australian shares prices move up and US share prices move down.) The flow of capital and price movements should happen immediately upon the release of new information about the respective economies.

All of this translates to the fact that our current strategy is sound. The last financial year, whilst not being outstanding, was almost exactly what you should expect over the long term from this type of investment portfolio. Return for growth portfolios was around 14% with small companies doing better than large companies, emerging markets doing better than developed etc. There was a slight negative effect due to Australian dollar movement.

I hope that this all makes sense.

Feedback welcome!

Wednesday, September 01, 2010

Elif Batuman in conversation with Richard Fidler

US writer and academic Elif Batuman fell in love with the great Russian writers after reading 'Anna Karenina' some years ago.

Broadcast date: Tuesday 31 August 2010 (612 ABC Brisbane)

Elif has discovered that when you read a truly great novel, it can work as a kind of vortex - drawing you into its world and its passions, and if you're not careful you can end up making important decisions about your own life as a result.

She wanted to explore the link between real life and books, and when she decided to chase up the lives and stories of the likes of Tolstoy and Dostoyevsky, she had no idea of the extraordinary places it would lead her.

Some of the many things she discovered on her bizarrre journey include the discovery that Isaac Babel once met and probably interrogated the creator of the original King Kong movie on a Polish battlefield - and that in the old Uzbek language they have 70 words for duck.

The Possessed: Adventures with Russian Books and the People Who Read Them published by Text

Brisbane Writers' Festival: Thurs 2 Sept GoMA Cinema A 2.30 pm/Sat 4 Sept The Edge 1.30 pm


Building Resilience

Jim Parker, Vice President, DFA Australia Limited
August 2010

'Risk' means different things to different people, but a common definition is as 'uncertainty'. Now, an entire science is being built around the idea of how we can cope better with the unknowable. And it has interesting parallels with investment.

What's known as 'Resilience Science' was the subject of a recent fascinating documentary on public radio in Australia, as an array of scientists revealed how new techniques are being developed to help society cope with rapid and unexpected economic, environmental and social change.1

"People are beginning to realise more and more that systems don't actually behave like we think they do," says Dr Brian Walker, a researcher with Australia's Commonwealth Scientific and Industrial Research Organisation.

The mistaken supposition, Dr Walker says, is that self-organising systems behave predictably and uniformly with small changes accumulating over time.

"But ... there are limits to the degree to which a system can cope with a shock and reorganise to keep functioning the same way," he says. "And once it goes past that limit, which we call a threshold or tipping point, it still keeps self-organising, but in a different direction, and often one that we don't like."

The role of resilience scientists, then, is to find and identify safe operating techniques within this system so that they can continue to cope when the unknowable and totally unexpected occurs.

Environmental journalist and author Mark Scheilstein provided an interesting analogy in citing the recent disastrous oil spill in the Gulf of Mexico or the flooding that followed Hurricane Katrina in 2005.

"When engineers look at major projects—whether levees in New Orleans or an oil rig in the Gulf of Mexico—not only do they have to plan for things they know about, but they have to plan for things they don't know about," he says.

"What happened in both of these instances is a very similar failing, in my mind on the part of the engineers" in that they failed to account for residual risk beyond the realms of their traditional expectations, Scheilstein says.

In environmental science, resilience is developed through building of reserve capacity, developing what's known as "modularity", diversifying food and energy sources, incorporating the idea of sustainability and increasing efficiency so that large exogenous shocks can be managed without the system falling apart.

Interestingly, similar ideas were explored in a financial market context in Sydney recently when Reserve Bank of Australia deputy governor Guy Debelle spoke to a conference on the concepts of risk and uncertainty.2

Debelle made the point that before the global financial crisis, many market participants had fallen victim to a form of hubris, believing that risk was totally quantifiable when in fact there would always be a degree of persistent uncertainty in the system that no model could account for.

"I don't want to get too 'Rumsfeldian' here, but an important element of risk management is to know what you don't know," the central banker said.

Because it was impossible to measure what we don’t know, policymakers and market participants needed to find ways of making the financial system as robust as possible in the face of this inherent and irreducible uncertainty.

So international policymakers in Basel are considering new requirements such as limiting the leverage of financial institutions, delivering a more robust funding structure to banks and enhancing their capital buffers.

Even then, the Reserve Bank deputy governor warned that no single model or combination of models can totally eliminate uncertainty.

"Risk measurement based on historical models can only take you so far. Judgement must play an important role," Debelle said. "Ultimately, the future is uncertain, in the sense that it cannot be quantified. The goal should be to design systems that are as robust as possible to this uncertainty."

The science of resilience is not unlike the approach to investment risk that Dimensional employs. That is, we must not only prepare for risky events that are within the confines of a neat model, but also must take account in our processes of what we don't know—outcomes beyond our conception.

This is achieved by building flexible, resilient, robust and dynamically integrated investment processes that can withstand rapid and unexpected change while maintaining the desired strategies.

Uncertainty in investment outcomes is dealt with through broad diversification, both across and within asset classes. The emphasis is on reducing the impact of idiosyncratic risk in a portfolio and focusing instead on risks that bear a long-term relationship to return.

Substitution is another technique. Traders are given discretion by being able to execute with a wide set of available orders. Not being wedded to an index or having strong convictions about particular securities also gives the investment team the sort of flexibility not available to other managers.

"Modularity" in science means the existence of modules within a network that can communicate and cooperate with each other, but which can operate independently if required. So it is with Dimensional's global investment process—with trading desks in Austin, Santa Monica, Sydney and London dynamically integrated but able to be self-sufficient if needed.

Finally, resilience science incorporates the idea that there are multiple ways of knowing and that our understanding of nature is always evolving. Creative solutions often emerge out of this process.

Dimensional takes a similar approach to investment, always testing its assumptions and encouraging a continuing dialogue between those who pursue theoretical research, those who do the practical implementation and the clients who keep us aware of their changing needs.

Ultimately, building resilience amid uncertainty is what our business is about.

1. Resilience Science, ‘Future Tense’, Australian Broadcasting Corporation, August 26, 2010
2. Guy Debelle, ‘On Risk and Uncertainty’, Risk Australia Conference, Reserve Bank of Australia, August 31, 2010

Tuesday, August 31, 2010

Sparking creativity at work: Michael Rennie

 From Life Matters on ABC Radio National

The modern business environment is anti-creative, says Michael Rennie, but every business wants to be more innovative, more creative.

And creativity makes us feel happy and productive. So why are so many workplaces the antithesis of buzzing, creative environments?

Why is creativity generally associated with the arts, not with business?

A conference in Melbourne next month called Creative Innovation will try to bridge these worlds, by bringing poets, musicians and thinkers together with business leaders.

One of the speakers has already crossed that bridge. He's Michael Rennie, Managing Partner of McKinsey and Company in Australia and New Zealand.


Taking Out the Middle Man

 Jim Parker, Vice President, DFA Australia Limited

One of the great benefits of the global internet is the scope it gives investors to test the veracity of media coverage by going straight to the source. Now, one canny consumer is taking this disintermediation a step further.

The structural crisis in commercial media has been cited before in this column, but boils down to the death of its traditional business model as advertisers and readers migrate to the web. The upshot is the media is left with fewer journalists to fill ever expanding amounts of white space and empty air time.

Some in the media are responding to this crisis by heading down-market. Essentially this means they are seeking to make a virtue of their lack of imagination and resources by sacrificing good information and context for public relations spin, circus-style entertainment and unadulterated opinion.

This is why TV business programs regularly feature people shouting over the top of one another and making a mountain over issues that really have little bearing on investors’ long-term returns. Overlooked amid all the sound and fury is the need for solid, independent reporting that adds value for readers and viewers.

One possible response to this noise is to go straight to the source. You can do that in the internet age. Instead of relying on second-hand and often inaccurate reports of, say, the International Monetary Fund’s global economic forecasts, investors can read the institution’s own summary on its website.

Smart consumers of media can also, using modern technology like RSS feeds and Twitter, follow the writers, bloggers and commentators they trust. Google Alerts provide another way to filter news of interest from the flotsam and jetsam.

In many ways, what is happening to the mainstream media is analogous to the crisis that started hitting the recorded music industry a decade ago. The old distribution model has been made redundant and consumers are empowered to access and customize the information they need directly.

One noted UK blogger and comedian, Tom Scott, has taken this trend of disintermediation a step further by designing amusing “journalism warning labels” that are attached to newspapers to alert consumers about the content therein.

Among the individual labels are “Warning: Statistics, survey results and/or equations in this article were sponsored by a PR company.” This is not surprising, given that one 2008 UK university study, based on 2,000 articles in five major British newspapers, found 80 percent of the content was second-hand. Most of it came either from public relations material or agency copy.

Taking note of this trend, Mr Scott has another warning label for newspapers that reads: “This article is basically just a press release copied and pasted.”

The growing dependency of journalists on media and publicity agents for softball interviews is highlighted by a fourth warning: “To ensure future interviews with subject, important questions were not asked.”

But probably the most salient warning label for investors is the one that reads: “Journalist does not understand the subject they are writing about.”

The fact is so much of what vexes investors comes from media content generated by journalists so pressured by deadlines and so desperate for content to fill the gaps between the ads that they really have little grasp of the often complex issues they are called to cover.

That’s the bad news. The good news is the very idea of the “media” – the thing that stands between consumers and events – is becoming rather quaint. The unadulterated information is there if you know where to look.

Friday, August 13, 2010

Broke and Broker

Each day, terabytes of broker research clogs the email inboxes of money managers. But how reliable are these multitudes of forecasts? New research in the Australian and the US markets helps answer that question.

Ploughing through broker calls is a professional hazard for those money managers who base their value proposition on the notion that they can make consistent returns for their clients by exploiting perceived market mispricing.

The hope is that among the volumes of forecasts will be the gem that will earn investors big money. But it seems there is growing disillusionment among forecasting-based fund managers about the quality of the broker calls.

Australian financial markets research specialist East Coles regularly surveys fund managers about the research they receive. Results of its most recent Best Broker poll featured in The Melbourne Age.1

The overwhelming impression left by the findings was that managers’ reliance on analyst recommendations has diminished over the years, in part because of concern over inaccurate forecasts and in part due to the perception of potential conflicts of interest between analysts and the investment banking and brokerage businesses of their employers.

"We rely on it [research] a bit,” one fund manager is quoted as saying, “which is unfortunate because it has been wrong throughout 2009."

Fuelling the cynicism was an absence of warnings over a number of high profile corporate collapses in Australia during the financial crisis, including the failures of Allco Finance, Babcock & Brown and ABC Learning Centres.

For instance, in September 2007, an analyst at a major investment bank reaffirmed his ‘buy’ rating on ABC Learning Centres after the company announced plans for further global expansion and said it would lift fees.2

ABC Learning at that time was one of the world’s biggest listed operators of child care centres, with more than two thousand centres operating in Australia, New Zealand and the United States.

Within a few months of that ‘buy’ rating being issued, ABC’s shares had collapsed from above $5 to zero and the company went into administration by September 2007 under the weight of $1.5 billion in debt.

In January 2008, an analyst from a high-profile Australian investment bank issued a report with an “outperform” recommendation on the Queensland property development group MFS and a 12-month price target of $7.15 from the then price of just under $4. A week later, the shares had collapsed by 75 per cent to $1.3 MFS subsequently went into liquidation.

For sure, there are good broker calls as well. But the East Coles survey found these are few and far between, which leaves fund managers wondering whether they would be better off with a dart board.

Further evidence of persistent inaccuracy in broker forecasts came in another recent survey, this time on the US market and carried out by management consulting firm McKinsey, updating a similar survey almost a decade ago.4

Analysing earnings forecasts for S&P-500 companies over a quarter century to the end of 2009, McKinsey found that with few exceptions aggregate earnings forecasts tended to exceed realised earnings per share.

Actual growth surpassed forecasts only twice in 25 years, the consultancy found, and both times during the recovery following a recession.

Instead, the survey found the most accurate expectations were actually those built into prices on capital markets themselves.

“This pattern confirms our earlier findings that analysts typically lag behind events in revising their forecasts to reflect new economic conditions,” McKinsey said. “Executives…ought to base their strategic decisions on what they see happening in their industries rather than respond to the pressures of forecasts, since even the market doesn’t expect them to do so.”

Good advice – and yet another reason to see market pricing as the best unbiased estimate of expected returns on capital markets.

1. ‘The Broking Analysts Who Make the Really Big Calls are Few and Far Between’, Michael Evans, July 17, 2010
2. ‘Childcare Giant ABC Tipped to Lift Fees’, The Courier Mail, Sept 15, 2007
3. ‘Debacle at MFS a Lesson to Others’, The Australian, Jan 21, 2008
4. ‘Equity Analysts: Still too Bullish’, McKinsey on Finance, Number 35, Spring 2010, McKinsey & Company

Tuesday, August 03, 2010

Missed it by that Much!

Jim Parker, Vice President, DFA Australia Limited
Market timing is hard; so hard that even the most experienced and respected market professionals struggle to finesse their exit and entry points. Just ask the famed hedge fund manager Barton Biggs.

Biggs made his name as chief global strategist with Wall Street investment bank Morgan Stanley. These days, he runs his own hedge fund and remains a regular media commentator on market trends.

In early July 2010, when market sentiment was the worst it had been since the crisis, Biggs announced he had sold half his equity holdings. Stocks had fallen nine times in 10 days and all the talk was of a double-dip recession.

“I’m not putting my money into anything,” Biggs said at the time. “I’ve taken basically all of it out in the US, and we had a broader exposure to consumer stocks and just, in general, I’ve reduced my net long position by about 30 or 40 percentage points.”1

That was a shame, as that point in early July marked the beginning of a turnaround in stocks that took the S&P-500 up more than 8 per cent in the intervening four weeks. Bolstering sentiment were solid earnings reports and more encouraging signs on the US and global economies.

In a radio interview with Bloomberg at the end of July, Biggs said he had now changed his mind and was rebuilding his positions in stocks.

“Economic data around the world in the last 10 days to two weeks has turned more positive,” he said. “It has exceeded forecasts almost without exception. The odds of the world slumping into a significant slowdown have diminished.”

None of this is intended to reflect poorly on Biggs’ skills as an investor. He clearly has a large market following and there appear to be plenty of people willing to back his judgment on perceived turning points.

But it does show the great difficulty facing even the most experienced and well informed investors in perfectly judging when to get into or out of the market. For everyday investors, then, the challenge must be even harder.

Research group Dalbar has charted this challenge for many years in its quantitative analysis of investor behaviour, a survey that shows investors almost ritually make the mistake of buying high and selling low.

In a recent interview with Barron’s, Dalbar founder Lou Harvey pointed out that many investors missed the boat yet again in 2009 by moving into safe investments like cash and missing the upturn when it came.2

The best protected investors, Dalbar found, were those who worked with advisors that put their clients first. By contrast, do-it-yourself investors tended to underperform those advised by a fiduciary.

“We found that people working with fiduciaries, advisors with a legal obligation to put the client first, and whose personal assets were on the line, tended to be among the winners - these clients were well protected,” Harvey said.

So it’s a familiar story. Investment advice is not about making predictions about the market. It’s about education and diversification and designing strategies that meet the specific needs of each individual. Ultimately it’s about saving investors from their own, very human, mistakes.

And, as we’ve seen, even the best of us make those.

1. ‘Biggs Buys Stocks Three Weeks After Cutting Holdings’, Bloomberg, July 26, 2010
2. ‘Did Investors Learn Anything From 2008’s Crash?’, Barron’s, July 24, 2010

Wednesday, July 21, 2010

"Rates Can Only Go Higher"

It seemed so obvious. With the economy slowly recovering last year from the worst recession in decades and the federal government seeking to tap the credit markets for over $2 trillion to fund an ambitious spending program, both laymen and experts alike seemed to agree that interest rates had nowhere to go but up. The yield on the ten-year U.S. Treasury note as of June 30, 2009 was 3.52%, down from 5.25% in June 2007 but well above the 2.09% level registered amidst the depths of the credit crisis the previous December. With retail sales and housing activity showing signs of gradual improvement, the only question appeared to be how much higher interest rates would go.

Among fifty economic forecasters surveyed by the Wall Street Journal in June 2009, forty-three expected the ten-year U.S. Treasury note yield to move higher over the year ahead, with an average estimate of 4.13%. Seven expected a rate of 5.00% or higher while only two predicted rates to fall below 3.00%. The result? The ten-year Treasury yield slumped to 2.95% on June 30, 2010 and rates on 30-year mortgages fell to their lowest level since Fannie Mae began tracking them in 1971. How many of us would have expected this during a period when gold prices soared over 33% to a record high?

Some observers may be tempted to poke fun at these hapless “experts”, implying they are incompetent or poorly informed. This interpretation is flawed since it suggests that a better team of experts would achieve a more accurate result. A more useful explanation is that even the most talented analysts are unlikely to make reliable predictions and the poor showing by this particular group is simply what we would expect to see, just as often as not, if markets are working freely and fairly. Today’s bond prices already reflect expectations for tomorrow’s business conditions and inflation and these expectations can change quickly in response to new information. However tempting it may be to believe that we can predict the future better than other market participants through careful study, the results of the Wall Street Journal survey as well as numerous other efforts suggest this confidence is misplaced.

What is the message for investors? Predicting interest rates and bond prices is no easier than predicting stock prices, and making decisions based on what appear to be certain outcomes at the time can often prove costly. Many investors reconfigured their portfolios in anticipation of higher interest rates and have penalized their results while they are waiting.

Instead of seeking to predict the unpredictable, investors are much more likely to enhance their results by focusing on the elements they can control – risk exposure, diversification and minimizing costs and taxes.

Yahoo! Finance accessed July 7, 2010. Wall Street Journal Forecasting Survey accessed July 7, 2010. Prabha Natarajan and Matt Phillips. “Stocks Drop; So Do Mortgage Rates” Wall Street Journal, June 25, 2010.
Mark Gongloff. “Two Treasury Forecasts: a Grand Canyon-Sized Gap” Wall Street Journal, April 10, 2010.
Tom Petruno. “Gold Hits Record as Investors Seek Haven” Los Angeles Times, June 9, 2010.

Tuesday, June 29, 2010

Sugar: The Bitter Truth

Robert H. Lustig, MD, UCSF Professor of Pediatrics in the Division of Endocrinology, explores the damage caused by sugary foods. He argues that fructose (too much) and fiber (not enough) appear to be cornerstones of the obesity epidemic through their effects on insulin. Series: UCSF Mini Medical School for the Public [7/2009] [Health and Medicine] [Show ID: 16717]

Friday, May 28, 2010

Jim Parker's New Book

Jim Parker, VP at Dimensional, has just published his new book, Outside the Flags 3: Discovering the Value of Good Advice.

In this book, the third collection of articles from his web column Outside the Flags, Jim Parker uses these topical issues to highlight the value of good advice:
  • Crises come and crises go, but lunches are still not free, return rarely comes without risk and patience remains an under-rated virtue.
  • If you are worried about bad news, chances are it is already in the price. Investing is about what comes next. We don’t know that so we diversify.
  • You don’t need luck to be a good investor. More useful are patience, discipline, a focus on costs, a willingness to diversify and a decision to take only those risks that come with a long-term reward.
  • The media builds neat narratives from messy reality. While often interesting, these are not something to base an investment strategy on.
  • Investors grappling with market turmoil often question the value of financial advice. Better to ponder the cost of bad advice.
 Please contact me directly if you would like a copy of Jim's new book.

Wednesday, May 26, 2010

Marco Pantani - 'Il Pirata' (the pirate)

Marco Pantani Jan 13, 1970–Feb 14, 2004 (died at age 34)
Italian road racing cyclist, one of the best climbers in professional road bicycle racing. He won the Tour de France and the Giro d'Italia in 1998... His career was beset by drug abuse allegations after a failed blood test in the 1999 Giro d'Italia. He died after a cocaine overdose in 2004...
Miguel Indurain, five-times Tour de France winner, paid tribute by saying:
"He got people hooked on the sport. There may be riders who have achieved more than him, but they never succeeded in drawing in the fans like he did."[13]

Friday, May 14, 2010

Fausto Coppi - "Campionissimo"

Angelo Fausto Coppi, 15 September 1919 - 2 January 1960 (died at age 40)
Comparing riders from different eras is a risky business subject to the prejudices of the judge. But if Coppi isn't the greatest rider of all time, then he is second only to Eddy Merckx. One can't judge his accomplishments by his list of wins because world war two interrupted his career just as world war one interrupted that of Philippe Thys. Coppi won it all: the world hour record, the world championships, the grands tours, classics as well as time trials. The great French cycling journalist, Pierre Chany says that between 1946 and 1954, once Coppi had broken away from the peloton, the peloton never saw him again. Can this be said of any other racer? Informed observers who saw both ride agree that Coppi was the more elegant rider who won by dint of his physical gifts as opposed to Merckx who drove himself and hammered his competition relentlessly by being the very embodiment of pure will.[14]
Coppi broke the world hour record on the track in Milan on 7 November 1942. He rode a 93.6 inch (2.43 metre) gear and pedaled with an average cadence of   103.3rpm.[15] 
The record stood until it was beaten by Jacques Anquetil in 1956.[9]

Thursday, May 13, 2010

Working in a Coal Mine

A recent media article hyped resource stocks, just a day before the Australian government slapped a big new tax on mining. Chalk it up as another reason not to stake your investment strategy on a single sector.

The illustration in The Australian Financial Review1 showed a miner's pickaxe breaking the dirt, showering sparks and diamonds. The accompanying text proclaimed that investors couldn't afford to ignore mining stocks.

Citing the extraordinary demand from China for raw materials, the newspaper said its own analysis showed the 100 best performing materials shares over the past five years had posted a median annual gain of 33 per cent.

The upshot, said the paper, was that investors needed to improve their knowledge of mining stocks to sort the speculative commodity plays in the equity market from the tried and trusted resource houses.

This all sounded very sensible…at least until the federal government the very next day unveiled a major tax reform package that had as its centrepiece a 40 per cent tax on the profits of mining companies.

Shares in global miners BHP Billiton and Rio Tinto lost 5.5 per cent and 7.5 per cent of their market value respectively over a couple of days. One broker estimated the tax, which takes effect in 2012, could reduce the companies' earnings by 17 and 21 per cent respectively in the first year.2

Of course, such companies as BHP and Rio are influenced by more than a single government's tax regime. Their market performance also came at a time of mounting concerns over Europe's debt crisis and its impact on global growth, a major determinant of commodity prices.

But this episode is yet another demonstration of why people should not seek to build their investment
strategies around a single idea or industry sector. There may well be a "commodity super cycle" underway, as some economists say, but investing this way introduces sector-specific and stock-specific risks that can be diversified away.

Dimensional breaks down equity portfolios not into mining stocks and banking stocks and healthcare stocks, but into broad asset class categories where the risk is related to an expected return.

This means a properly diversified portfolio will include large stocks and small stocks, growth and value stocks, domestic and international stocks and emerging market stocks. The exact mix will be determined by the needs and risk appetites of the individual investor.

It should be said that some of these portfolios may well include BHP and RIO, particularly if the investor chooses a dollop of large cap stocks. But the important point is that the portfolio is not built around a view about the mining industry or its prospects.

Ultimately, successful investing is not only about successfully capturing risks that offer an expected return, but reducing risks that do not. That means limiting one's exposure to random forces and not falling into the temptation of basing an investment strategy on an economic forecast.

Otherwise, it is like working in a coal mine—dark, dirty and dangerous.

1'Your Guide to Mining Stocks', The Australian Financial Review, May 1-2, 2010
2'Rudd Tells Australian Miners He'll Pursue Tax Plan', Bloomberg News, May 5, 2010

Wednesday, May 05, 2010

Esther Duflo’s TED talk

Esther Duflo - Short Bio

Facebook and Twitter

from @SocialMedia411 ...

Facebook is for people you went to school with. Twitter is for people you wished you went to school with.

Tuesday, May 04, 2010

Talking About a Revolution

Jim Parker, Vice President, DFA Australia Limited

Australia's financial advice and retirement savings industries are about to undergo a revolution aimed at protecting investors, curbing conflicts of interest, lowering costs and improving transparency.

At the centre of reforms, unveiled by the federal government recently, is a ban on commissions paid by fund managers to financial advisors and on any other conflicted remuneration structures. The ban applies from July 1, 2012.

The reforms came out of an inquiry called by the government after a series of scandals in which investors were shoehorned into inappropriate investments by advisors compromised by sales incentives.

Alongside the ban on commissions, the government plans to introduce a statutory fiduciary duty requiring advisors to act in the best interests of their clients and to put their clients' interests ahead of their own.

The reforms have received almost universal approval from industry bodies, including the Investment and Financial Services Association, the Association of Superannuation Funds of Australia and, in a more qualified way, by the Financial Planning Association.

A separate inquiry, meanwhile, is seeking to simplify and make more efficient Australia's system of compulsory superannuation, or retirement savings. A preliminary proposal is for the creation of a single, low-cost, simplified and diversified investment strategy for the vast bulk of Australians who do not want to exercise choice in superannuation.
Taken together, the reforms are seen likely to strengthen advisory businesses that already employ fee-for-service models and which are not compromised by compensation provided by fund managers.

This is close to the new model of advice long promoted by Dimensional — one in which the interests of the client are paramount. In the old model, a product manufacturer paid commissions to an advisor (in reality, a facilitator), who in turn sold proprietary products to a customer. In the new model, the pyramid is reversed so the advisor's interests are aligned with those of the client.

In this view of the world, clients are much more inclined to stay the course and meet their financial goals. They get what they really want — help in making wise financial decisions. Advisors become true fee-based professionals, focusing on the needs of their clients and freed from having to "sell product".

The other aspect of the reforms — creating a more efficient retirement savings system — also ties in with Dimensional's long-established message. That message says that investors should focus more on things within their control, like keeping costs down and reducing taxes, and less about factors outside their control, like market volatility and media noise.

It truly is a revolution. And it has been a long time coming.

Tuesday, April 27, 2010

Hard Sells, Harder Lessons

Jim Parker, Vice President, DFA Australia Limited

Sometimes you need to see the worst practices of the financial services industry to understand why it is worth paying for good advice. Take, for instance, what's been happening in New Zealand.

Huljich Wealth Management is an accredited distributor of KiwiSaver, a voluntary work-based savings initiative set up by the New Zealand government to encourage Kiwis to grow wealth for their retirement.

The Securities Commission launched an investigation into Huljich after the company's founder, principal shareholder and managing director Peter Huljich admitted he propped up the fund with his own money in 2008.

Huljich later admitted his wrongdoing and resigned as managing director and chief investment officer. While the firm insists no member lost money as a result of his actions, the controversy has hurt the company's reputation.

At the same time, the Securities Commission has expressed concern over aggressive marketing techniques by distributors of KiwiSaver, including high pressure door-to-door selling and inducements to sign up right away. Huljich is alleged to have been one such aggressive marketer.

"The commission has become aware of a number of circumstances where KiwiSaver membership has been solicited in an unusual or confusing manner. This type of behaviour is completely unacceptable and damaging to investor confidence," commission chairwoman Jane Diplock said.1

According to one newspaper, Huljich sold the superannuation scheme to two intellectually disabled students who had little idea what they were signing. One was under the legal age and the other had a reading age of 8.

In some cases, investors did not know they were committing to KiwiSaver. Some thought they were purchasing household products. In other cases, inducements were offered for long-term membership. Some people were even offered the chance to win a $100 shopping voucher if they signed up.

The controversy over KiwiSaver is not what the New Zealand financial services industry needs, as it struggles to restore its collective reputation after a series of scandals in recent years involving finance companies.
A total of $1.5 billion of investors' hard-earned savings were lost in those collapses in 2007-08, a blight on the New Zealand securities industry that the commission's chairwoman blames on a patchwork regulatory framework.2

A common theme in the scandals is a lack of understanding among the general public about the difference between an independent financial planner and a sales person for a product distributor. The latter receives incentives to sell product, while the former is paid by their clients to build a customised financial plan — including a diversified investment portfolio - designed around their individual needs, aspirations and risk appetites.

The government is now attempting to address this by putting up for discussion a draft code of conduct for authorised financial advisors, which sets minimum standards of competence, knowledge and skills, ethical behaviour and client care which advisors would have to meet.

At the core of the code of conduct is a requirement that when providing advisory services, authorised advisors must place the interests of their clients first and must act with integrity.

Advisors would not be able to characterise their advice as "independent" when they are being paid by a person other than the client or are under a contractual obligation to recommend a particular product.

Dimensional has long argued that financial advice is best left to independent and professional advisors who are directly familiar with their clients' financial experience, risk tolerances and individual goals.

The relationship between Dimensional and advisors is not tainted by commissions or other incentives. Rather, it is founded on shared ideas about how markets work, a joint commitment to education and a common goal in ensuring clients have a good investment experience.

The investment philosophy is also a sound one. No market timing or forecasting or speculation is involved. It is not about fickle fashion or ego-driven claims by individuals about being able to "beat" the market.

Instead, it is about working with the market to build diversified portfolios around risks that rigorous research shows are related to return. It is about keeping costs as low as possible and about being mindful of taxes. And it is about staying disciplined.

There are no hard sells in this view of the world - just an unchanging commitment to the welfare of the individual investor.

1'NZ Commission Warns KiwiSaver Funds', NZPA, March 24, 2010
2'The System is Broken: We Need to Fix It', Jane Diplock, NZ Herald, March 26, 2010