Third quarter mutual fund roundup: Buy, buy, buy!
October 11, 2008 on 2:14 am | In Money | No Comments
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Withdrawals from mutual funds that invest in emerging markets soared in the third quarter as investors sought refuge in safer assets. But amid the market mayhem, many equity fund managers saw reason to be optimistic. Their message: Buy, buy, buy!
Investors pulled $24 billion from emerging market equity funds and $11 billion from bond funds in the three months from July through September as financial storm clouds continued to gather, according to EPFR Global, a group in Boston that tracks fund flows.
Some of these markets registered their worst declines ever during the quarter. September marked the fourth consecutive month of decline in the Russian stock market, the second-longest period of decline in its 13-year history, excluding the aftermath of the 1998 debt default. The benchmark RTS index lost 26 percent in September and a substantial 50 percent since its peak in May. The Central Bank of Russia estimated that net private capital outflows from the banking system and other sources amounted to $16 billion over the quarter.
Europe equity funds, meanwhile, extended their losing streak with withdrawals of $7 billion in the quarter. The financial stress on the European financial system was reflected in the poor performance of funds invested in the region. Data compiled by Morningstar, the funds data group, indicate that the average European equity fund shed more than 5 percent of its value in the three months through Sept. 30.
There were, however, pockets of good news. French equity funds pulled in $900 million in August and September - a surprise development that many observers attributed to the “Sarkozy effect,” or optimism about the policies of President Nicolas Sarkozy.
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“The sense that the president's taxation and labor relations policies will be positive for domestic equities seems to be an important factor in the fund flows,” said Brad Durham, an analyst at EPFR Global.
In spite of equity market turmoil and the failure of U.S. policy makers to agree quickly on a $700 billion rescue package, U.S. equity funds pulled in a net $39 billion during the third quarter. This was less than the previous quarter, which saw inflows of around $55 billion, but it appears to indicate that not all investors were cashing out because they feared Armageddon.
“Substantial flows into U.S. large-cap value funds suggest a flight to quality,” Durham said. “The U.S. remains for many investors the safest option in an uncertain world.”
This is a paradox that will not escape the many investors who lost money on their U.S. holdings: The average U.S. mutual fund dropped 6 percent over the quarter, according to Morningstar.
It was a good quarter for China funds, which attracted solid flows in the range of $2.8 billion. Vincent Strauss, director of Comgest Magellan in Paris, has been avoiding China since late last year, but his instinct now is to load up on consumer stocks, which “look attractive at current levels,” he said. “Consumer goods manufacturers are attractive as they will benefit from the falloff in raw material prices.”
Strauss is doing his homework before making a move.
“We want to avoid investing in companies where major shareholders have borrowed to invest,” he said. “The last thing we want is to be at the mercy of forced sellers.”
While few fund managers are prepared to predict the bottom of the market, they expressed a feeling that when buyers come back, they will be seeking quality. History has demonstrated that previous emerging-market sell-offs - in 1994 after Mexico devalued the peso; in 1997 after the Thai baht devaluation; in 1998 after the Russian sovereign debt default; and in 2001 after the Sept. 11 attacks in the United States - were all opportunities to pick up emerging market equities on the cheap.
Derek Hong, a senior fund manager with National Bank of Abu Dhabi, believes that now is the time to “load up the truck” to take advantage of a great investment opportunity. Hong favors Arabtec Construction, which trades at a modest price-earnings multiple of seven and boasts revenue growth of 60 percent. Arabtec, Hong said, “will eventually find buyers once the markets settle down.” Hong also likes four other Gulf stocks - Dubai Financial Market, Gulf Navigation, First Gulf Bank and Sorouh Real Estate - because he thinks they are likely to show “very significant” price appreciation over the next 12 months.
Jacob Grapengiesser, a senior fund manager with East Capital, an emerging markets specialist based in Sweden, is backing Russia. “Russia has been punished severely for perceived political risk,” he said. “But the government is aware of the problems and doing everything it can to get the market back on track.”
Lessons in dealing with volatility
October 4, 2008 on 8:14 pm | In Money | No Comments
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The extraordinary volatility gripping the markets culminates a year in which wrenching price swings have become almost commonplace. Stocks, bonds, commodities and currencies have made moves in minutes and hours that in normal trading only occur over the course of days or weeks.
Investors, well off and humble alike, must cope with the turbulence, but those in the first group often pay professionals to do the coping on their behalf. Private bankers, uptown financial planners and others who cater to wealthy clients employ various strategies to help insulate them from, or even profit by, extreme volatility.
The safest approach is to try to sidestep the ups and downs by maintaining especially well-diversified portfolios. Further insulation can come from adjusting holdings to limit exposure to inherently more volatile asset classes, like stocks and commodities, and increase investment in high-quality bonds and cashlike instruments, which normally have smaller fluctuations.
“A very broad-based asset allocation” is the first step in dealing with volatility, said Chris Cordaro, a partner at the financial planning firm RegentAtlantic. He acknowledged, though, that when conditions become acutely difficult, as they have been lately, and volatility spikes, diversification becomes less effective.
“Correlations go to one in a crisis,” he said, meaning that everything goes down together. But they do not stay down for long, he assured: “Coming out of this, diversification is going to work, so there's no reason to abandon it.”
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Rather than trying to parry away the effects of heightened volatility, many advisers tackle it head on in various ways. A safe, straightforward approach, one that is available to investors who have modest portfolios and no outside help, is to rebalance the weightings of various investments.
It is essential when building a portfolio to establish risk parameters and allocate money to different assets accordingly, said Harold Evensky, a financial planner at Evensky & Katz. As markets rise and fall, certain holdings will occupy greater or lesser proportions of the overall portfolio than desired, a process that is exaggerated when volatility rises.
Rebalancing involves adjusting the weightings to bring them back in line with the original plan. An investor who wishes to maintain 55 percent in stocks and 45 percent in bonds, for instance, might sells stocks and buy bonds whenever the ratio goes to 60/40 or do the reverse when it hits 50/50, Evensky said.
That is one way to get the preferred result. Another, said Brett Hammond, chief investment strategist at the fund manager TIAA-CREF, is to do it periodically, say every year or two. “But whatever rule people follow,” he advised, “they should look at their portfolio now because it is likely to look significantly different from how it looked a couple of years ago.”
Another way to manage volatility is to treat it as an asset in itself. There are securities, amounting to cocktails of derivative instruments, that provide higher returns when markets have endured big swings and investors anticipate more of the same.
These structured products, as they are known, are created by investment banks and are not publicly traded. That usually makes them available only to wealthy investors.
Alexandre Zimmermann, head of advisory and investment solutions for SG Hambros, a British boutique private bank, has been increasing his use of structured products since the beginning of the year as a way of “selling volatility.” One vehicle he mentioned pays 10 percent a year for three years as long as the FTSE-100 index of British stocks does not end the three-year period 50 percent below where it started.
If the index does drop that much, investors will be on the hook for the loss, he said, but that would have been the case if they had simply put their money in stocks. Mitigating the loss is the 10 percent they would still pocket for each year that the index did not experience that steep decline.
The protection comes at a price, Zimmermann said; investors are giving up any gain in the index. But he said his clients did not mind.
“They are happy to move from a capital-appreciation strategy to an income strategy while keeping the same underlying risk,” he said.
But it is precisely because the climate is so iffy that Cordaro, the RegentAtlantic planner, would think twice about using these vehicles. They work only if the banks that invent them, and take the other side of the trade, pay up, and that is by no means certain these days.
“With the whole structured-products market, you've got counterparty risk,” he warned. “That was extremely evident” last month.
One way for small investors to avoid counterparty risk and profit from volatility is to sell exchange-traded call options against stock they own. In return for cash, shareholders take on an obligation to sell their stock at a fixed date and price in the future. Volatility is a significant component of an option's price, so this strategy is likely to be more profitable in a climate like today's, all else being equal.
The new face of private philanthropy
September 29, 2008 on 8:58 am | In Money | No Comments
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Ken Weeman can remember a time when he and his wife, Kathryn, wrote dozens of personal checks every year to charitable organizations they knew relatively little about. Overwhelmed by the ritual, Weeman, a former Dresdner RCM Capital partner who lives in California, stood back one day and realized that he was “clueless” about the impact of his family's giving.
Changing tack, Weeman reduced his family's portfolio of charities down to 10 carefully selected entities, 4 of which he is directly involved with today. Among them is Clínica Verde, a U.S.-based nonprofit group created in late 2007. Its mission is to build clinics aimed at improving maternal and infant health care, beginning in Nicaragua, which has one of the Hemisphere's highest rates of adolescent fertility and maternal mortality.
Weeman, who is semi-retired, is a founding board member for Clínica Verde. In this capacity, he plays an active role directing the organization's financing, which includes some $275,000 in private donations. By crunching numbers and asking questions - including “impertinent” ones about goals and budgets - Weeman came to the conclusion that “for a relatively little amount of money, we could save a lot of lives.” The charity will break ground on its first clinic in 2009, which will one day provide a medical home for about 4,000 children and prenatal care for 1,500 high-risk pregnancies per year.
Experts in charitable giving say Weeman's experience is typical and points the way to the future of individual philanthropy.
“People want to give responsibly,” said Caroline Garnham, a senior partner in the London law firm Lawrence Graham and founder and director of Family Bhive, a philanthropy Web site for ultra-high-net-worth individuals and their advisers. “What they don't want is to give money and feel they have lost all control over its outcome.”
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While Garnham expects the current U.S. financial market crisis to further solidify this attitude, she does not think it will stem the tide of giving. If anything, it could help it along. According to Garnham, her clients know they have surplus wealth that could be put to good use during tough economic times. The big question is how?
Charitable giving has been a challenging proposition at least since the days of Andrew Carnegie, who was once quoted as saying, “It is more difficult to give money away intelligently than it is to earn it in the first place.”
Given the unprecedented number of charitable organizations in the world today, the learning curve associated with philanthropic giving has never been steeper. In the United States alone, there were about 904,000 public charities registered with the Internal Revenue Service as of 2006. In Britain, as of this year, there were an estimated 180,000.
Small wonder, then, that potential donors may feel ill-equipped to navigate this new landscape - especially when they are approached in a high-pressure manner, like at a fund-raising auction. Garnham said her clients tell her they are tired of being “shamed” and “bullied” into parting with their money in haphazard fashion. “There is a lot more suspicion about money finding its way into the hands” of the persons on whose behalf it is being solicited, she said.
Donor anxiety is a very real issue, said Katherina Rosqueta, executive director of the Center for High Impact Philanthropy, at the University of Pennsylvania. Her organization recently conducted a survey of 33 ultra-high-net-worth Americans - all of whom had the capacity to give a minimum of $1 million per year in charitable donations. While Rosqueta said the majority of the respondents expressed “a desire to use more of their wealth for philanthropy, many seemed unable to do that confidently.”
Surprisingly, perhaps, this response is coming from a group of people whose wealth in many instances was earned as opposed to inherited. “You are talking about some very successful people who had real achievements in their professional life, but none of them have been well educated or well trained in philanthropy,” Rosqueta said.
Until recently, opportunities for individual philanthropists to research the efficacy of their charitable donations were scarce. Even when they did exist, donors often avoided them, fearing that direct inquiries would result in unwanted solicitation.
Online information services like GuideStar and Charity Navigator are helping improve the transparency and accountability of charities. The two collect financial data from hundreds of thousands of charitable organizations, repackaging the data for philanthropists and their wealth advisers. They are picky about those they list. Charity Navigator evaluates only public charities - organizations given tax-exempt status under Section 501(c) (3) of the Internal Revenue Code and have filed a Form 990 with the IRS. Likewise, entities must show high-level public donor support of at least $500,000 and have at least four years of filed tax forms.
Should you buy or sell into the bailout?
September 29, 2008 on 8:58 am | In Money | No Comments
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The striking ups and downs in the stock market offer something for everyone.
The blastoff in the stock market just over a week ago that carried the Dow Jones industrial average nearly 1,000 points higher over four trading hours furnished some bulls with the sign they had awaited that the trend had changed. For investors who think the glass is half empty and may contain something toxic, the cascade that followed confirmed that the rally was just another chance to dump stock.
So what do investment advisers think is the right thing to do now, buy or sell? The consensus is: neither.
Whether they are hopeful or fearful, analysts and fund managers contend that the best course of action is to hold back and wait to see what develops next. During this period of extreme volatility, that is an option that few investors seem interested in taking, but there are good reasons for bulls and bears to give it a try.
Among many unknowns, the biggest one concerns the government agency being created to take bad debt off the hands of financial-service companies. Congressional leaders announced Thursday that the broad outline of a deal had been worked out, but just a few hours later, it became clear that no agreement was at hand. And even if a bailout bill is passed, it is likely to remain unclear for months what the cost and the impact on the economy and financial system will be.
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“Transferring assets that are so difficult to price into this vehicle is not going to be easy,” Mark Schmeer, chief investment officer for global equities at MFC Global Investment Management, cautioned. “That's one of the details that might create speed bumps for the market.”
The closest thing to a precedent may be the Resolution Trust Corp., set up in 1989 to engineer an orderly disposal of real estate and paper assets from failed savings and loans. If the economy and stock market follow paths similar to what they did after the RTC was formed, buyers have good reason to hold their fire.
David Rosenberg, chief North American economist at Merrill Lynch, recalled in a note to investors that the Resolution Trust liquidations were deflationary enough to delay a trough in economic growth for two years and in the housing market for three years.
Sam Stovall, chief investment strategist at Standard & Poor's, pointed out that the agency did no favors for stocks either. Financial stocks rallied slightly in the weeks after the agency was set up, then lost nearly half their value over the next year. The broad market did better, but not well, trading sideways for 15 months.
One difference between conditions now and then is that stocks and the economic cycle were rising in 1989, not mired in long slumps, so the Resolution Trust Corp.'s value as a road map might be limited.
Even if there is more room for improvement today, it may not happen immediately. Stovall noted that bear markets often ended for good only after a low was made and then approached again and sometimes exceeded slightly.
A successful retest of a low tends to occur on lighter volume and is “less emotionally gut-wrenching,” he said. The mood at that point is closer to resignation than panic.
Stovall is reserving judgment on whether the retest will confirm a lasting low. Schmeer is more confident, in part because so few of his peers seem to be.
“There is a lot of bearish sentiment,” he said, noting that recent surveys of investment newsletter writers showed twice as many bears as bulls, an extremely rare event. Another sign of nervousness was very high readings over the summer on measures of market volatility.
Nearly universal anxiety is almost a prerequisite for a bear market bottom. It is what prompts the last sellers to bail out, clearing the way for the next rally.
Schmeer expects the low set last week to hold. Even if it doesn't, he says he is confident that the next significant move is up, although he is not sure it will be easy to get there.
“I think stocks will be materially higher a year from now,” he predicted, “but we still have tough sledding to get through.”
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Maybe short-selling isn't so bad, after all
September 29, 2008 on 8:58 am | In Money | No Comments
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U.S. regulators have banned short sales of more than 800 stocks, mostly of financial companies, in an effort to stabilize prices in a shaky market. But the move may have an unintended consequence: reducing the stock market's efficiency and prolonging the current crisis.
That's the consensus of several finance professors who have devoted considerable energy to the study of short-selling — a mode of trading in which a profit is made from a price decline. Short-sellers, like investors who go “long” on a stock, make money by buying low and selling high. The difference is that short-sellers reverse the usual chronological order, selling first and buying back later, at what they hope will be a lower price. They accomplish this time switch by selling borrowed shares and agreeing to return them later.
Were short-sellers ganging up on various stocks in the recent tumult, causing prices to plummet? Adam Reed, a finance professor at the University of North Carolina at Chapel Hill who has extensively studied short-sellers' behavior and its effects on the markets, said it was “hypothetically possible” that they were. He added, though, that the question still needs study because real-time information about these possible “bear raids” isn't available. But he would be surprised if short-sellers were a major cause of the market's turmoil over the last year.
“In recent years,” he said, “when academic researchers have looked for bear raids — even in those areas in which investors suspected that they existed — they haven't found them.”
Consider a group of 19 beleaguered financial stocks for which the SEC restricted short sales between July 21 and Aug. 15. Arturo Bris, a finance professor at IMD, the Swiss business school, who also is a research fellow at the Yale International Center for Finance, analyzed short-sellers' behavior in the months before this SEC action. He concluded that the poor performance of those 19 stocks in the year leading to that action “cannot be attributed to short-selling activities.” One of the statistics on which Professor Bris focused was the so-called short-interest ratio, which is calculated by dividing the number of shares held short by the average daily trading volume. On average, those 19 stocks had short-interest ratios that were no higher than those of other financial stocks in the year leading up to the SEC policy change. And here is another telling statistic: While the SEC restrictions were in place, these stocks, on average, actually performed worse than the rest of the market.
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What about the dismal performance of many financial stocks earlier this month? It's too early to know, Professor Reed said, because the data are not all in. But here, too, he said he doubts that short-sellers played any significant role.
Consider, for example, what short-sellers did on Sept. 9, a day that rumors circulated widely about a possible bankruptcy at Lehman Brothers and Lehman's stock fell 45 percent, to $7.79 from $14.15. According to Professor Bris, the average price at which short-sellers sold Lehman stock that day was $9.29, significantly closer to the day's low than to the high. That implies that they were reacting to the downward momentum, not causing it.
Typically, Professor Bris said, “short-sellers trade in response to past negative news, rather than inducing current stock price drops.”
What about “naked shorting” or “failure to deliver” borrowed shares, a practice that was the focus of the SEC restrictions in July? These terms are used to describe a breach of the standard practice in which a short-seller has three trading days to actually borrow the shares he is selling short. Naked shorting has been blamed for some of financial stocks' recent woes, but Professor Reed says this claim isn't supported by the evidence.
Each day, the exchanges publish a list of stocks for which there has been even a very small number of failures to deliver. In recent months, according to Professor Reed, the large financial stocks have hardly ever appeared on those lists.
Then there is the abolition of the so-called uptick rule on short sales in July 2007. When the rule was in place, a stock could not be sold short unless its last trade was higher than its previous traded price. The rule, put into effect in the 1930s, was intended to prevent short-sellers from accelerating the downward momentum of an already-declining stock.
Has the rule's removal been an important contributor to the bear market of the last year? Professor Reed doubts it. Before scrapping the uptick rule, the SEC ran a pilot program to test the possible consequences. In the test, the rule was lifted from hundreds of stocks that were part of the Russell 3000 index. The trading patterns of these stocks were exhaustively analyzed in a number of academic studies, all of which concluded that the rule had no significant impact on those stocks' price movements, Professor Reed said.