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THE BLUE MONEY REPORT.
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The Blue Money Report
"...contributors will only give money to challengers when they have a realistic chance of winning, and incumbents only spend a lot when they have a chance of losing"
~ Steven Levitt
Welcome to the Blue Money Report
Today's Commentary: 08.29.03 Before I get those answers, there is something that I would like to address. Even as Thomas Carlyle suggests, "All work, even cotton-spinning, is noble; work alone is noble", this Labor day I would appreciate it if you thought about those folks who do similar jobs. In this country 30 million people work and labor, often with great nobility earning wages that fall below the poverty line. These Americans are the same folks who pump your gas, clean your office floors, or process the food you will consume this weekend.
By all means, have a safe and enjoyable holiday.
What happens when a fund manager leaves and should I care? wrote John from Albany, N.Y. I believe that there is a good deal to be concerned with a manager's exit and I responded with this note:
Dear John:
We should be picking mutual funds using some criteria. Even if we haven't developed a good long range plan, how we pick a place to park our investment until we fully develop one is important. Mutual funds should be picked with track records. Has the fund done well over the last three to five years? If so, has the same person been at the helm?
This person can receive the lion's share of the credit for the well being of your money. Using their performance as one of the criteria for picking a fund (the other two being no-load and expenses) can be worrisome if you hear that this person is leaving. It doesn't really matter that their new job might be a good move for them. Your money shepherd has left for a new flock.
If this happens to you, don't panic. First thing is determine that person's influence. Recently at the Buffalo Small Cap fund, Tom Laming decided to depart. This fund, which by way of disclaimer I should tell you I own and is included in our Early Bird Portfolio, was part of a management team at Buffalo. His departure according to the fund will not impact the remaining two members of the team. Unfortunately, you now need to be a bit less passive about your investment.
Managers are supposed to provide good communication to their shareholders about direction, frank comments about performance, and any changes in their strategy or investment outlooks. If this continues much the way it had in the past, you can probably count on some sort of continuum.
If you fund had a solo manager, your watchfulness should be on high alert. Give the new person about six months or two quarters. By then, they will have positioned themselves and the result of any portfolio realignment will begin to show up. Be especially alert for any huge tax consequences as result of portfolio shifts due to sales or shareholder redemption. An exodus by fellow shareholders is not a good sign.
Active-trade managers have funds that reflect their style. Index managers merely watch the helm and adjust the benchmarks. A much more complicated question arrived from a young lady in Sacremento. She wondered what exactly was an exchange traded fund and whether they would be good for her?
Dear Cyan:
I say essentially for a reason. They are primarily traded on the American Stock Exchange and are basically a basket of securities (stocks issued by companies) that follow an index. Vanguard and Fidelity have entered the market recently with ETFs following Merrill Lynch and Barclays who have been using these types of passive funds for years.
So what are they really? They are clever instruments designed by clever institutional investors who play this game at an entirely different level than you and I. The first ETFs were dealt directly from the brokerages or mutual fund companies to the individual. Buying meant that you bought the basket of securities but selling was another thing altogether. When an ETF is sold back to the brokerage, the investor does not get their money returned but the underlying stocks in the fund. This is good for those who can buy the fund at a discount to its Net Asset Value in the morning and sell those discounted stocks for a profit in the afternoon. The Net Asset Value of ETF is calculated in much the same manner as a mutual fund would. The NAV calculated by the mutual fund does not reflect supply and demand. Supply and demand are primary forces in the open market and because of that, the share price of an ETF may be trading higher or lower than the underlying worth.
ETFs outperform mutual funds in terms of flexibility though. The ability to trade throughout the day is one of the primary attractions for investors interested in ETFs. Frequent traders however may fell the sting of commissions more than those who chose another longer term strategy.
Two things make these shares worth avoiding. The first is that pesky problem of discount. In a market correction, ETFs may be on the surface, worth more than the NAV of the securities they represent. The second deals with expenses and the possible illusion that you are saving money. I have always encouraged dollar cost averaging, low expenses, and low entry fees for the mutual funds here at the BlueCollarDollar. ETFs would not fit that criteria. Dollar Cost Averaging, the act of making regular and steady contributions to a fund to offset high and low markets would rack up an enormous amount of commission costs. One lump sum purchase, perhaps with a windfall or a tax return check would be the best wait to fully realize the value of such a trade. This is the very reason Dollar Cost Averaging works so well. Buying the NASDAQ 100 or ticker symbol QQQ, a tech laden grouping of the top stocks on the NASDAQ at the high dollar mark of $110 would find you with a share worth two thirds less today. Using dollar cost averaging, the hypothetical investor would be purchasing shares at this greatly discounted price and with any luck, it will offset the share they bought back in '00. The current closing price at this writing (08.27.03) is down only 10% from the inception price of $50.
Expenses are considerably less than many index funds but this is also a smoke and mirrors effect. Unless you hold onto the ETF for a sufficient amount of time to offset the cost of the purchased ETF and the expenses, you are probably better suited for a mutual fund.
One of the most under considered expense is taxes. In a mutual fund, an investor sells shares and the whole fund feels the ripple effect. In order for that investor to receive the value of their investment, the fund must sell something to pay off the departing shareholder. This can negatively impact the remaining long term investors. If the stocks that are sold have experienced gains, taxes must be paid. In the world of ETFs, this exchange is done between other shareholders and doesn't impact anyone other than those involved. Be aware though of two things that can be considered taxable and unavoidable. The securities in an ETF may still pay capital gains distributions. The second one is an indexing problem. When the fund needs to rebalance because of a change in the benchmark, stocks sold may have capital gains as well.
The choice of ETFs over mutual funds should be considered very carefully. In a long term investment strategy that employs dollar cost averaging, the benefits of ETFs fade very quickly.
Below you will find a list of these funds along with some pertinent information.
The NASDAQ 100 Index reflects NASDAQ's largest companies across several major industry groups, including computer and office equipment, computer software and services, telecommunications, retail/wholesale trade, and biotechnology.
SPDRS
SPY SPDR 500
iShares Funds
iShares are a family of open-ended exchange-traded funds that seek to track the performance of any of an array of market indexes, such as the Russell 2000 Value Index or the Dow Jones US Consumer Cyclical Sector Index.
IWM iShares Russell 2000 Index Fund
Diamond Funds DIAMONDS is the common name for a specific index ETF that seeks to track the Dow Jones Industrial Average (DJIA) index by investing in the constituent stocks of this index.
streetTRACKS Funds
streetTRACKS is a family of exchange-traded funds that are marketed by State Street Capital Markets and represent ownership in the streetTRACKS Series Trust, an index fund that consists of separate portfolios of common stocks. Each fund is designed to track a specific index, such as the Dow Jones Total Market Index Series (US Large-Cap Value, US Large-Cap Growth, US Small-Cap Value, US Small-Cap Growth), Morgan Stanley Internet Index, Fortune 500 or the Fortune e50 Index.
DSG streetTRACKS DJ US Small Cap Growth
Today's Commentary: 08.26.03 October 31st is now in the sights of every mutual fund manager. It is that mark on their investment calendar, that could ruin a good many of the more risky bets you may have made. On the other hand, it might be your lucky day. Unlike hedge funds, mutual funds can not short the market as a way of offsetting losses. On the 31st day of the tenth month, mutual funds must have sold and declared their losses, an exercise that individuals need not worry about until two months later.
The heads up comes at the expense of some stocks that are already beaten down. Many of these funds would rather sit tight on many of these companies, but the cost of taxes prevent that from happening. For individual investors, many stocks that appear as a value play may have more downside left in them than you might anticipate. The old saying about a stock that's down 50% will need to climb a 100% to get to even may hold some sway here. With long term investors that have held on to some losers for yet another year, their effort to bail might overwhelme your effort to buy.
With this market showing signs of apparent strength across the board, could there be a less risky way of playing the potential upside? I believe, and I have said so before, that small cap growth stocks, in particular small cap growth mutual funds will lead the way. The numbers have this to be the case in the first half of the year. These companies do tend to be at the leading edge of recoveries. The risk it seems, lessens somewhat among small caps in a fund for two reasons. One, it spreads the risk of volatility among many different companies offsetting serious downdrafts that many companies with low liquidity often face. Secondly, in an up and down market, the larger the capitalization of a company the greater the chance that it will act like the old cliché of a boat on the tide. High tide raises all boats, low tide takes them down. This sort of buddy system of rising and falling can make companies that are well positioned to tap the bond market for ready cash less concerned about stock prices.
Low tide may be sooner than most of us want to think. Before I embark on this last little tidbit it is only far to say that this applies to those long term strategists. For too many of us, the thought of holding an individual stock for a decade or longer outside of our own company stock in our pension, is unfathomable. It happens though and is shaping up as not the wisest thing to do now.
Suppose you had adjusted your holdings to reflect this much longer horizon, say for the sake of discussion, ten years. If this particular time frame does not bump into your own retirement, think for a moment what you will be doing when you do reach that moment. Every financial planner worth their mettle will suggest some sort of realignment of your asset allocation. In many cases this will involve selling stock of companies that you have held for a long period. When this takes place in a short period of time spread over many different investors all thinking the same thing, the amount of shares that suddenly become available on the open market will skyrocket as the price of those same issues plummets under the burden of increased supply. Those first wave of boomer retirees will be selling stock in old growth companies, enterprises whose best growth days may well be behind them. They will be selling businesses whose dividends have remained constant over the years, perhaps even accelerating during certain recovery periods, but whose growth has barely kept pace with the GDP or inflation and certainly not the combination of the two.
Sure there will be some high growth companies around but older conservative investors won't care. Those younger upstarts will only skew the average return that will be available to the total market, making it higher than it might reflect if it took into account the maturity of these older companies and how they will slow the process. What if the markets average earnings growth over the next several decades doesn't do better than 4%? Then it becomes a question of yield.
It is really yield that we are looking for, not returns. Taxes, inflation and a whole host of other costs can eat away at your return but yield is the bottom line result of your investment decisions. If dividends average above 1.5% and I believe it is slightly higher that that now, adding these two numbers, growth plus dividend yields together begins to make the 30-year Treasury a comparable investment at a much lower risk.
It isn't like me to suggest more than twice in the same month the same remedy for this little observation but it still look as if it might be the wisest position for the long term investor. Municipal bonds and Treasury Inflation Protected Securities (TIPS) I have to admit might be same thing as suggesting to a child: "Don't talk to strangers". Just common sense.
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