Archive for the ‘IVA Funds’ Tag

Dear index buyer, you too are an active investor

The “consensus” view of personal finance right now is that we should all be index investors. It’s been well documented that active mutual fund managers have a poor track record of getting above-average returns. According to Standard & Poor’s, the S&P 500 beat 72% of active funds that invest in large companies. So, the theory goes, stick with a mutual fund that simply invests in everything and charges an extremely low fee.

But even if you’re an index investor, you do ultimately have to make choices about your asset allocation. You need to decide how much you’re going to put in a U.S. stock index fund, how much you’ll put in a U.S. bond index fund, an international index fund and on and on.

At first, financial planners and magazines like mine started making recommendations about that allocation based on readers’ ages and risk tolerance. Then “balanced” funds came along. They would let you decide on what mix of stocks and bonds you wanted based on your age or risk tolerance, and the fund manager would maintain that 50-50 (or 60-40, 70-30 etc) mix between a stock index fund and a bond index fund.

I previously wrote about my interview with Chuck de Lardemelle and Charles de Vaulx of IVA Funds. As part of my end-of-the-magazine-cycle clearing up of my desk, I listened through the interview again. De Lardemelle and de Vaulx run active funds that cross all asset classes. They can move money to cash, high yield bonds, U.S. stocks, international stocks, gold…you name it.

For a passive investor trying to build out his asset allocation, such a fund is a nightmare. If you invest in a set of mutual funds and an IVA Fund is one of your picks, you might think you have 50% of your money in stocks and 50% in bonds. But if de Lardemelle and de Vaulx decide to, they could swing the balance in one of their funds from stocks to…gold. Or, recently, to high-yield bonds.

So here’s the question: Should you decide your asset allocation or should an “expert” do it?

You can’t answer, “But I’m a passive investor! I invest based on my age and risk tolerance.” To me, allocating based on age is also an active choice. You’ve decided that in the long-term, certain historical trends will continue, making an age-based portfolio the most likely solution to get you to your goals. 50% of my savings will go into stocks today just as 50% went into stocks at the height of the tech boom and the trough of the tech bust.

I’ve seen enough evidence to convince me that most active managers are poor stock pickers. But I haven’t seen a lot of research telling me one way or the other if active managers are poor asset pickers.

Here’s what de Lardemelle said when I asked, “Since they don’t have much time to devote to thinking about investments, shouldn’t our readers just allocate a certain amount of their portfolio to each asset class and be done with it?” When reading his answer, keep in mind that he’s trying to sell his fund.

You’re right that it’s hard to pick companies to invest in internationally if you don’t spend time doing it. But if you try to do it yourself through index funds, what you’re basically doing is trying to figure out an asset allocation. And that’s not that easy either. You need a lot of data. You need a lot of experience. Usually the stuff you want to be in is the stuff that’s been forgotten by anybody and everybody.

There are few funds that have taken on that challenge of being a fund for all weather and that can shift gears from one asset class to another. Usually you have a mutual fund that does Southeast Asia, another fund that does small-cap value in the U.S. or whatever. That is I think how we differ from so many others. We can do high yield, cash, gold. There are few funds like that. I think it is a small piece of the market that’s going to grow. Basically, financial advisors themselves are looking for funds that take the burden of asset allocation off their shoulders.

Is that the right path? I’m waiting for someone to come out with an actively managed fund that only invests in index funds. “That’ll be the day,” you scoff. But is that much different than hiring a financial advisor to determine your allocation?

Update: After thinking about it for a bit longer, I guess actively managed funds of index funds do exist. Many target retirement funds or balanced funds have investment committees that tweak allocations based on what they see in the marketplace. I never thought of target-based retirement or lifestyle funds as being “active” funds before but I guess that’s not far off base.

– Joe Light

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Sure, you should invest globally, but I’d stay away from stock picking if I were you

Sorry this was late. I was about to just not post and mark it up to being busy. But I’ve been able to keep up posting every business day so far, and think you guys deserve at least something to show that I am, in fact, working, right? For any of you non-investors out there, this might delve a little into the obscure, but I’ll try to keep it as basic as possible. Trust me, it concerns you, too. map-of-japan

It must be really hard to manage a mutual fund that invests in international markets. Imagine having all of the same concerns about analyzing companies that domestic fund managers do and lay on top of that dozens of different political realities – in one economy (Russia), the government might even decide to nationalize a company, making your investment worth nothing.

Another, maybe more confusing situation was brought to my attention yesterday in an interview with two fund managers from IVA Funds. IVA is a relatively new mutual fund shop brought to you by Chuck de Lardemelle and Charles de Vaulx (among others). They’re all value managers and earned their street cred while working for First Eagle, under renowned investor Jean Marie Eveillard. In fact, even though their IVA Worldwide fund is only six-and-a-half months old, Morningstar’s already given them a hearty endorsement. (I linked to the A shares, but they do have a load-waived share class).

I’m not about to endorse a fund that’s only been around for half a year (or put it down), but I can tell you that they were smart, interesting guys.

One of their more contrarian assertions was that Japan, despite having a price-to-earnings ratio that’s relatively high compared to the rest of the world (last I checked, it came in at around 14), is one of the most undervalued markets.

Their reasoning? Well for that, we need a little bit of a history lesson. Japan suffered its own asset price bubble in the mid-80s. It popped, of course, and Japan went through an extremely slow and painful deleveraging process to bring prices back to Earth. For a time, companies couldn’t borrow money.

As de Vaulx explains it, that fear of running out of money has trained companies to stockpile huge cash hoards “just in case”. You’d think that having an “emergency fund” as a company might be a good backstop in the way it is for an individual, but for investors, it’s meant that Japanese companies have a low return on equity and don’t increase shareholder profits. For a good summary of the problem, click here.

How does that make a good value? Well, because of all that cash on their books, the P/E of a Japanese company gets distorted. Imagine a company that costs $50 on the market and has earnings of $1 per share. That’s a P/E of 50 and is pretty bad, right? But what if it had $45 in cash per share on its balance sheet after taking out all debt. Now, the $50 per share doesn’t look so bad. That’s why a lot of investors look at a company’s “enterprise value” rather than the P/E. To calculate enterprise value, subtract the cash per share (or if they have debt, add the debt per share) to the company’s stock price before dividing by the earnings. In the preceding example, the company’s enterprise value-to-earnings ratio would be 5. (Note: This can work the other way too. If a company has more debt per share than cash per share, the enterprise value ratio would be higher than the P/E.)

Japanese companies have a lot of cash, and that’s why Chuck and Charles think they see great deals in that area of the world.

To me, what isn’t clear is the last step required to make those companies worth investing in. If they don’t ever return the cash to shareholders, isn’t it worthless? Imagine if Google decided it would never pay a dividend for as long as the company was in business and instead hoarded the money or paid it to employees. The stock price would (and should) be $0.

So it seems a bet on Japan is a bet that the culture of those companies changes or that investors force it to change. Otherwise, that cash is just one hell of an emergency fund.

I often say that most investors should let professionals do the investing or stick with an index fund that simply tracks the market. But given the cultural and political complications that come into play internationally, I think a novice would be crazy to try to pick foreign equities on his own. There’s just to much to wrap your head around.

– Joe Light