In the never-ending quest for the unpopular asset class that you might be able to pick up on the cheap it is difficult to go past commercial real estate at the moment.

But there are a few problems:

1. commercial real estate can be very illiquid
2. with the gearing in this sector, falling property values, and historically low interest rates that may increase, there may be risk in a particular fund that it is hard to identify

So what might be interesting would be a commercial real estate exchange traded fund that is both liquid and spread across a number of different property trusts.

In Australia you can find exactly this with the State Street Spider S&P/ASX 200 Listed Property Fund (roughly $15 billion market cap with 16 holdings and a .4% management cost with quarterly income distributions).

SLF Net Asset Value has halved over the last year

If your approach to buying stocks is chartist/technical, stop reading here because the chart (ASX:SLF)
 is a bit ugly to look at, with net asset value at 1/2 of its 12 month high, and down 2/3rds over the last 2 years.

SLF ETF fall in net asset value since Aug 08

We have started (and intend to continue) buying it in multiple small parcels and as a long term investment.

SLF income picture

SLF is currently trading at a  nominal double digit yield which is estimated to fall to about 8-9% i.e. you can assume that a further fall in income distribution is already factored into the current price.

Roughly 7 out of 10 of the top 10 holdings are trading at single digit PEs and the outlook from analysts for the whole property industry is still gloomy.

Stock-Specific Risk in SLF

It seems strange to talk about stock specific risk with an ETF but as of August 7th Westfield made up 47% of total assets so if you don’t like Westfield don’t buy this (here are the top 10 holdings): 

Here’s the sector breakdown:

Like it? Hate the idea? Let us know by commenting below!

Posted under index trackers

Beliefs of Americans about investment returns from different asset classes

The thing that has bothered me over the years about investing in low cost equity tracker funds which eliminate all that stock-specific risk and have historically performed far better than any other asset class, is that they seem like such a no-brainer. Surely it is so obvious that everyone can see this with average actively managed fund performing worse than low cost passive vehicles?

And if everyone can see this then isn’t there going to be a whole pile of ‘dumb’ money piling in driving index constituents to ever higher price earnings multiples, whilst ignoring the fundamentals of these stocks? Who’s going to be left to actually look at individual stocks to do the number crunching to really evaluate their value?

Ok, I realize that nobody ever went broke (particularly casinos) by basing their business on the public thinking they were cleverer than the average Joe but still? Admittedly there is also a lot of rubbish quoted out there that makes it look like stocks do not offer good long term returns. One of my pet hates is writers just quoting the index e.g.

“the S&P is back where it was 10 years ago”

and the writer not realizing that, for example, (from Standard and Poors) dividend income has represented roughly 1/3rd of the monthly total return on the S&P 500 since 1926, ranging from a high of 53% during the 1940s to a low of 14% in the 1990s (when investors focused on growth).

But there is also a huge amount of very compelling research identifying long term returns on different asset classes…

It looks like I needn’t have worried about crowd mentality when it comes to trackers looking at this survey though!  Sadly another thing that stands out about the Gallup results is that lower income investors are more likely to view savings accounts as better investments (obviously imposing an inherent ceiling on their growing their personal wealth) although equally oddly higher income investors believe most in investment in real estate!

The study also bears out that  we investors are so into driving by looking into the rear vision mirror … with equities (now that they represent better value) falling in popularity by 15% or so over the last 2 years (the same survey has been carried out since 2003) and bonds and cash which have performed better over the same period (despite the forward inflationary risk with a wall of government debt bearing down on us) becoming much more popular…

Posted under index trackers, investment strategies

It will not have escaped people’s notice that shorting some indices last year would have been very lucrative. What about in 2009?

As a company we do some business with Hong Kong and Chinese clients. Recently we’ve been receiving letters in response to our invoices which read along the lines of:

“whether there is a possibility of a one-off discount for this year.. In view of the economic clouds and down cycle on the horizon our ..budgets for 2009 are very tight and in fact downsized – we would very much appreciate your kind and considerate courtesy in this matter.”

At the same time there is quite recent investor comment around about shorting China. For instance the Christmas edition of MoneyWeek suggests using the ‘Ultrashort FTSE/Xinhua 25 Proshares (US:FXP), an exchange traded fund that matches 200% of the inverse movement in the Chinese market.

However, looking at an indices chart of emerging markets  comparing the FXI (the long version of the FXP) and the Indian equivalent (the BSE30) and the Dow Jones index both China and India large caps have tracked down very closely (and at least 10% more than the DJI) at levels of 50% or so.

Admittedly China is not the worst emerging market performer of last year (Russia is down for example some 70%) but this does not appear to be a ‘new’ story (on a 5 year view these indexes are down some 150% from the heights they reached at the end of 2007) so one suspects that shorting China at this point could be a risky business. 

In ‘short’, this boat has sailed.

Posted under index trackers, investment strategies

The whole market is on sale, 30%+ below its high.

So it doesn’t matter what you buy, you can just buy a tracker fund / index fund right? That will give you a low risk, low cost, highly diversified bet on the long term value of equities. Sure, you may want to drip-feed funds in, because it could fall another 20%.

We….ll, as ever, maybe it’s not that simple.

Industry sector weights in the ASX 100

For example, if you look at the broader Australian stockmarket, you find that actually were you to buy an ASX 100 tracker you are effectively taking a bet on two sectors in a big way, financials and mining. For instance Jun 2008 S&P sector weights show that the ASX 100 is 8.41% energy, 28.17% Financials-ex-Property, and 30.1% materials. In other words 64% of the large cap end of the index.

Industry sector weights in broader ASX indexes

So what about a broader tracker, for instance the State Street SPDRs tracker for the ASX 200?

Well this is actually a similar sector bet. For example Oct 2008 figures (i.e. even after the credit crisis fallout of the last 12 months) show a sector weight of 39% on financials, and 21% on materials, and 6% on energy, a total of 66%…

It is only when you get to the ASX Small Ordinaries (companies in the S&P ASX 300 but not in the S&P ASX 100) that financials drop to 7% but materials is still 31% and energy is still 14% taking the weight for the 3 to 51%.

You can not buy a tracker of the Small Ordinaries, you’d have to look at a managed fund like BT Microcap Opportunities or the equivalent, so in a sense this is rather academic, but it does give you a pointer to the extent that the Australian economy is dependent on these sectors, even after a commodity price fall and the banking price fall.

Sector weights in UK indexes

The FTSE 100 is 22% oil and gas, 21% financials, and 15% basic materials as of June 30 2008, another significant bet on mining and banking.

However the FTSE 250 is a significantly more diversified bet: 27% financials, 6% oil and gas, and 5.4% basic materials as of 30 June (probably significantly less of a financial and mining bet as of Oct 2008).

Non-standard ‘stylistic’ trackers can also give you some variation on the standard sectors. For example, the FTSE UK Dividend Plus tracker, which consists of the highest dividend yields in the FTSE 350 filtered by specific liquidity requirements, is 32% financials and 4% oil and gas as of 30 June.

Aren’t trackers about not guessing themes?

None of this is to say that we should be trying to guess what themes will do well (for instance a tracker that is heavily weighted to financials and diversified might not be a bad thing to buy at the moment).

It is also the case that not all trackers are equal. So-called ‘Enhanced Trackers’ where the managers have some freedom to track the index somewhat more loosely and use derivatives, supposedly often perform better over the longer term by anticipating index departures and arrivals, but more of that later.

Posted under index trackers, investment strategies

When is it worth stepping back into the US market as a foreigner (in a broadly diversified drip-feed way)? With the S&P 500 now sitting 50% below its peak you could be forgiven for thinking there might be a bargain out there.

Here are some things it might be worth taking into account:

• market valuations
• currency risk
• appropriate indicators like risk aversion 
• average length of recessions

Not on this list are technical indicators – apologies, basically we are not amongst the true believers.

Market Valuations on the S&P 500

Market valuations on the S&P 500 had it on a forward concensus PE of around 12 at the end of September putting it around 11. Since then it has dropped another 10%+ (end of September S&P 1099, today Oct 9th  984). However some estimates have it on a forward basis of 15 or even 19 or higher (at the $48 a share earnings estimate mentioned in this article on the Big Picture blog) on the basis that analysts have been known to be over-optimistic about earnings …

15 actually might well be the long run average but in previous recessions PEs have actually got down to 10 (see this article to see historical PE fluctuations) implying a further fall might be entirely possible.

Currency Risk on US Equities

One would think that in the medium term the $700 billion bailout last week is not good news for the US dollar (for example, it will represent a 24% increase in the 2008 US Federal Budget):

“total government commitment and proposed commitments so far in its current and proposed bailouts is reportedly $1 trillion compared to the $14 trillion United States economy” [Wikipedia]

 However in the short term there has been a flight to US dollars in relation to UK sterling and Australian dollar by around 12% and 30% (!) respectively (it is likely the A$ has been punished by the fall-off in commodity prices as well as general risk aversion).

At the risk of trying to predict the future of currencies (a mug’s game as everyone from Warren Buffett to your neighbour Frank can tell you) one would have to wonder when the immediate perceived risk related to bank solvency starts to decline whether the $US is in for a fall – essentially this bailout has given everyone a new reason to dislike it.

How risk averse are equity investors at the moment?

Very averse … The VIX volatility index aka ‘the fear gauge’ which measures the cost of options hit a record high yesterday (Oct 8th) and this kind of VIX level has previously been associated with market bottoms.

Average Length of Recessions

The ‘average’ recession is about 12 months but on the plus side it does seem that recessions have become both less frequent and milder (see NBER study information in previous link). Is the current credit squeeze different – almost certainly – but equally there are many other things that are different in 2008 as well, ranging from technology to world trade.

The ‘Bottom Line’ – buy the S&P 500 now or wait?

At the moment I am inclined to wait. Mainly because I would like to see the US dollar come off a bit as opposed to any other reason. However the other indicators are looking pretty positive. It is of course impossible to pick the exact bottom but if you were within say 15% of the bottom in 2002 you still would have been up 50% within say two and a half years.

Posted under index trackers, market timing

When it comes to investment strategy for self managed super funds or self invested personal pension plans, unless you are a retiree with lots of time on your hands or a very competent stock picker, index/tracker funds or actively managed funds are probably going to play some role.

In making the choice for your SMSF strategy between passive trackers and actively managed funds there are two commonly cited reasons as to why you should choose passive versus actively managed funds:

1. Cost – and specifically the impact of management costs over the long period of a superannuation fund investment. According to Rainmaker’s most recent survey, cited in the Australian, “the fee varies according to what you buy: workplace super funds average 1.41 per cent, personal super funds average 2.03 per cent and retirement funds average 1.86 per cent. ‘Out of that, the weighted industry average is 1.36 per cent,’ says Andrew Keevers, Rainmaker’s associate director of research.”

Of course this includes ‘unavoidable’ costs like compliance costs but it also includes perhaps more avoidable costs like trailing sales commissions paid to advisors.  It is not an entirely fair comparison (simply because it does not include super-specific running costs) but the management expenses of something like the iShares IJP tracker runs at .5% (and that’s not the cheapest tracker around).

1% or so difference between an actively managed fund and a tracker doesn’t sound like much on the face of it but the impact of just 1% over a longer period can be quite high. For example, from memory the average SMSF in Australia is around $250,000. Assume two SMSFs, one with passive trackers, one with actively managed funds (with slightly higher expenses) are both held for 15 years starting with a balance of $100,000 (to make it simple I have assumed no new contributions). Assume the same return of 6% p.a. (see point 2 below about returns) but a 1% higher management fee in the actively managed fund so the net return on the passively managed SMSF (after expenses) is 5% and the net return on the actively managed SMSF (after expenses) is 4%:

So a 1% difference in returns compounded over 15 years leads to a 20% difference in the value of the fund on retirement … now imagine the impact with new contributions every year plus longer timelines given increasing life expectancy…

2. Returns – tend to be lower in most managed funds than passive funds. Whilst individual managers may have periods of outperformance this tends not to last.  It is sometimes thought that active fund managers may perform better in bear markets, but even this doesn’t look like it is true:

“Lipper Inc. studied active managers’ performances in bear markets (defined as a drop of 10% or more in the equity markets). Lipper found that active managers underperformed the S&P 500 Index in the six market corrections occurring between August 31, 1978, and October 11, 1990. For example, the average loss for the S&P 500 Index in these episodes was 15.1%, compared with a 17.0% average loss for large-cap growth funds.” [Source Vanguard] 

Both these points are commonly cited when it comes to comparing active management and tracker funds. However the advantage that you do not see mentioned so much relates to entry and exits.

Whether you are picking stocks yourself, or paying an active manager to do it for you, it often seems like the hard part is knowing when to sell … knowing when to buy is much easier.

For instance, if you are a value investor (you tend to buy stocks that you think are undervalued on say price/sales ratios or PE or whatever) broadly speaking one of two things is likely to happen, you were right (it was undervalued and the price goes up), or you were wrong (it was actually overvalued because it had a load of debt that it is having trouble refinancing and that wasn’t captured in the ratios you used).

Assuming you picked well at what point do you sell? When it’s priced at the correct ratio? What if things have changed in the business and it’s long run returns look better?

And if you picked badly how do you recognise this? If you are a value investor a la Mr Buffett you’re supposed to ignore the price falling and just buy more … but what if the fundamentals in the industry have changed (like Mr Buffett you quite like the newspaper industry but increasingly everyone is getting their news for free online)?

Add to this the well known predilection that people have for finding it hard to cut their losses and finding it equally hard to let their profits run, rather than take them too quickly, and it is easy to understand why so many private investors (and fund managers!) end up portfolios full of dogs. It’s not that they can’t recognise value when they see it: it’s that they can’t recognise when they’re wrong, and equally they don’t know when to sell when they’re right…

The great advantage of tracker funds is that they make these buying and selling decisions for you without your emotions coming into it (and without your time being spent on constant re-evaluation of your picks).

Posted under index trackers, investment strategies

With the problems at Merrill Lynch, AIG, and collapse of Lehmans, there will be some people who have been sitting on the sidelines in cash who may think this is a bleak enough moment to start dribbling cash into the market.

This is not one of those ‘on the one hand & on the other hand’ articles in that I spent 10% of my SMSF cash holdings today on buying 3 (fairly poorly researched) index trackers, but as someone noted to me this evening it is easy to want to get back in too quickly (the possibly apocryphal example given was that of JP Morgan who waited from 1929 to 1939 to start buying again).

The same person noted that that ASX index had now fallen from 6800 to 4799 but that the next support level was at 4200 (confession: I neither believe in or understand charting in anything but a rudimentary sense when it comes to equities).

There was some muttering about if we hit 4200 we would be in for “10 years of poor returns”.

‘Typical bear markets’ fall 25% and that is where we are now in most major markets.

So I went looking today for poor performing markets over the last couple of years where I could start to nibble at low cost index trackers, which had gone on to fall even more after the weekend’s events.

I ended up buying small holdings in 3 iShares trackers that just happen to be in Asia that have not performed very well over the last 5 years and have fallen even further over the last few days (the charts are for the underlying indices and not the tracker):

I am even tempted increasingly by the S&P500 which got to 1500 last year and is now sitting 20% lower just below 1200 (back where it was in 1998!) but wonder if there will be another US dollar fall that might be a better entry point given that I am not a US resident (the USD is up 10% against the $A in the last few weeks).

Posted under index trackers, market timing