Investment Articles

We all use timber on a daily basis, in our houses, our furniture, our floors and our roofing, and institutional investors, hedge funds and pension funds have been investing in timber as a long-term growth asset and inflation hedge for decades. However, as more investors discover the little-known fact that timber investments have generally outperformed stocks, bonds, and commodities over the long run, there are now many opportunities for the smaller investor to participate in this alternative asset class.

The demand for timber is growing in line with an ever-expanding population, as the human race multiplies in number we require more timber for construction, yet at the same time, fundamental limits to the supply of natural forests limit the amount of timber we can grow and harvest for our own use.

Deforestation has destroyed 1/5th of the world’s forests since 1950, and new global legislation is in place to protect the forests that remain as they play a vital role in carbon sequestration and the ecosystem.

This imbalance between supply and demand creates an outstanding opportunity for investors to acquire assets in short supply and profit from undeniable fundamental trends of population growth and resource scarcity.

Investment Performance
The vast majority of return on investment generated by timber is derived from the biological growth in size of the timber source, from seedling to sapling to fully fledged tree. On average, a single tree’s volume of wood will increase by between 2% and 8% every year depending on species, age and climate. On a very basic level, this gives the tree owner more timber to sell as time passes, and hence generates a greater return in the long-term.

Aside from this basic observation there is more to consider, as trees yield a greater sale price when they grow into bigger product classes. As an example, a small tree would only be suitable for paper products or biomass for fuel, where a larger tree can be harvested for sawn-timber which will fetch dramatically higher prices per tonne and can be used for products such as plywood or telephone poles.

A study by Professor John Caulfield of the University of Georgia found that biological growth counts for more than 60% of total financial returns, whilst increases in the price of timber, and capital appreciation of the land account for the remainder of returns generated from a timber plantation.

This goes to show that it is an effective strategy to lease land on which to grow timber, as well as purchase outright as only 6% of profits are derived from capital appreciation in the value of the land. This also shows that fluctuations in the price per cubic metre or tonne of timber have limited influence on the overall performance of timber investments. The majority of return is generated from the growth in the size of the tree itself.

The standard benchmark for timber is The NCREIF Timberland Index, which increased 18.4% in 2007, versus a 5.5% rise for the S&P 500. In the long-term, the Timberland Index has outperformed all major asset classes including, large-cap stocks, International equities and corporate bonds.

Whilst small-cap equities have outperformed timber in the long-term, after factoring in risk (as reflected in the Sharpe Ratio), timber has exhibited the highest risk-adjusted returns of any major asset class. When compared to the S&P 500, timber has displayed a low risk characteristic. Since its 1987 inception, the NCREIF Timberland Index has fallen in only one year: – 5.25% in 2001, at the same time, the S&P 500 has fallen four times, including -22.10% in 2002.

One of the main reasons investors, especially large institutional investors, turn to timber, is the fact that the asset displays low to zero correlation with other assets, especially those linked to financial markets. It has been demonstrated over a long period of time that adding timber to a portfolio of investments has the effect of improving overall risk-adjusted returns. This low correlation reflects
the fact that the primary driver of returns-biological growth-is unaffected by economic cycles.

Institutional Investor in Timber

In 2007, Jeremy Grantham, Chairman of Grantham Mayo and Van Otterloo, a Boston-based firm that oversees $60bn in assets, predicted the impending financial crisis, one of very few Investment Managers to do so.

At a conference in June 2007 Mr. Grantham announced that equities were overpriced to such an extent that the market was as risky as he has ever seen it. “The next few calendar years,” he warned, “look like a black hole as overpriced markets, dangerous leverage and a gigantic hedge-fund business collide with the house-building phase of the US presidential cycle, plus the contraction phase of a long interest cycle.” His prediction? He said he could see the Standard & Poor’s index falling 38% over the next two years.

He went on to say that Investors should allocate capital to timber investments as a stable and predictable asset with a low risk profile where returns are generated outside of any market. It is the only asset class in existence that has gone up in three out of the four major market collapses of the 20th century. It
should be noted that Jeremy Grantham holds 20% of his personal investment portfolio in timber assets.

Institutional investors have recognised the benefits of timber investments for some time, Pension funds such as Calpers, led the way in the 1980s, however it was the big university endowment funds such as Harvard and Yale that saw the true potential and invested heavily in a move to diversify their portfolios globally. In 2009 the Harvard Endowment Fund invested $500m in forestry and carbon credits in New Zealand.

PKA, the DKK 114bn (€15.4 bn) Danish collective pension scheme for employees in the public social and health sectors, raised its forestry investments to about €335m by the end of 2007, raising its commitment to timber from 1.5 to 2% of total assets.

ABP, the €211bn Dutch pension fund made its first timber investment in 2007 with a $60m (€41m) allocation to the Global Solidarity Forest Fund (GSFF), which will develop three sustainable forestry projects in the Republic of Mozambique, in south-eastern Africa, and Angola.

Both the £1.5bn (€2.1bn) UK Environment Agency pension fund, the £31bn Universities superannuation Scheme and the £3.6bn London Pension Fund Authority are reviewing whether to inject money into forestry investments.

European Investment Bank (EIB), the €26.3bn Ilmarinen Mutual Pension Insurance Company and seven medium-sized Finnish pension funds have all invested in timber via the Dasos Timberland Fund.

Massachusetts Pension Reserves Investment Management Board (Mass PRIM) decided to make a $500 million timber investment just three years after selling a $700 million section of its timber portfolio.

More recently there has been a spate of new timber investment by major asset managers, not least the $1 billion takeover of Canadian timber business TimberWest by two large asset management firms acting on behalf of institutional pension funds.

At the time of writing this report in December 2010, there looms the prospect of a second round of quantitative easing (QE2) by both the US Federal reserve and possibly the Bank of England too.

QE2 should help to shore up the US housing market. Construction accounts for roughly 70% of the total value of timber resources and as the US property market recovers, inflation will rise as houses increase in price once more.

One such asset is timber which has a proven history as an excellent hedge against rising prices.

The US housing market (construction accounts for roughly 70% of the total value of timber resources and QE2 should help to sure up the US housing market. As the US property market recovers, inflation will rise. As house increase in price once more.

Timber as an asset class presents unique characteristics. The performance of forestry assets is driven primarily by the natural growth rate of trees independently from the macro economy. As a tree matures its size and usefulness increases and subsequently so does the price. In a difficult economic climate timber companies have no need to discount their crops because if simply left to grow the value of the asset only increases.

This makes timber much less volatile in the long run and more resilient in difficult times compared to most other commodities as the investment is backed by the underlying real asset value of timber. Timber is recognized as an inflation hedge as trees grow in size, and therefore value each year. If inflation were 3% and your trees grow in size (value) by 5%, you have grown your wealth in real terms ahead of inflation.

As the rate of inflation increases, so to do timber prices, as well as the volume of timber you have to sell. This creates a double-buffer for investors and makes timber investment an ideal balancing tool to diversify portfolios.

There are a number of different opportunities for retails investors to participate in timber investment in various forms. In this section we will focus on direct investment within commercial timber plantations, although the reader should be aware that there are other, market-linked opportunities such as forestry funds and listed timber companies.

The basic premise of all of the investment offerings from various companies that we have researched remains relatively static,in that investors are usually invited to purchase either a lease on a plot of land within a commercial timber plantation, therefore owning cropping rights to any timber produced within their plot or woodlot. An alternative to this is where investors are offered direct ownership of a fixed number of trees.

The cost for plots varies from project to project between £5,000 (GBP) to £22,500 (GBP) depending on the size, location and species of timber being grown.

Sometimes, annual fees are required from the investor to service the costs of on-site management, and of course the occasional thinning that is always required within a commercial plantation.

With other projects, sufficient management fees for the period of time up to the first harvest are paid up-front by the vendor and held in escrow, fees for future harvests are deducted from the revenue of each preceding harvest, therefore creating an investment where no further cash input is required from the investor.

With some projects the land is leased by the forestry company and investors enjoy a sub-lease, with others the land is owned outright by the forestry business and investors have a direct lease and the land held in trust in favour of investors until their lease expires, this mitigates the risk of the forestry business ceasing to trade in the future and the investor left with a sub-lease with a business that no longer exists.

Download your free guide to timber investments and forestry investments at http://www.dgcassetmanagement.com

After discussing Differences between Savings and Investments, we will further discuss Investments to see what important factors an Individual Investor must keep in mind before making actual Investment decisions. From First and Seconds Lesson on investment, we have darted down certain points which classify investments from savings, and have noted few factors there that an individual investor must keep in mind to make wise investments, or even, to make investments at all or not.

This Lesson will cover in detail, factors and checks that are or should be backbone of investment decisions.

1. Avoid Hasty and Un-Planned Decisions. In a volatile market and financio-economical situation like present, it has been observed that investors are making rapid investment decisions without involving much planning and analysis. Investors, out of fear and/or lust factor, seem to have ignored and put aside their long term financial goals and all that long planning they had done in a normal market situation. This kind of behaviour must be avoided as it may, and mostly does, add to the already piling up losses. You financial plans may be revived, trimmed and modified but should not be completely ignored as you have had put some hard work and thinking while making those financial plans and setting your financial goals.

2. Draw or Re-Draw a Personal Financial Road Map. As discussed previously in my post on Having a Plan before Writing a Business Plan, we discussed how important it is to know and analyze one’s personal financial position before making any kind of financial decisions. We stressed there that an investor(which in that case was for a proprietor) should first thoroughly analyze his current personal financial position, keeping in mind his future plans regarding his personal life, future major expenses, future earning options i.e. both expected amount and timings. One should have enough cushion for one’s near and far future personal plans, and then see how one can set aside to invest into a new investment)

If you are already very much vulnerable to a financial crisis, based on your current financial condition and future expectations, you should avoid the idea of risking your finances even more by even thinking of a new investment.

3. Knowledge, Expertise and Skills related to Investment. It is always advisable to invest in something you have yourself knowledge and expertise of, instead of completely relying on Investment Managers(if you are going to hire one). If you think you have keen interest in an investment and it is not very technical to handle, you can even yourself manage your investment and save costs. But again it is more advisable to at least have some guidance from one. Having knowledge and expertise of a particular investment class will enable you to make better decisions and look for more innovative and modern ways of investments. So even if you don’t have know how and you trust a particular investment management company, before investing do detailed research and try to get as much as knowledge as possible of the subject, which in this case is an investment.

4. Asses you Risk Tolerance Capacity. Every investment involves some sort of risk, as this is something that differentiates Savings from Investment. If you are investing in stocks, bonds, real estate–there is definitely risk involved. As compared to depositing in Secured Banks. The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals. The principal concern for individuals investing in cash equivalents is inflation risk, which is the risk that inflation will outpace and erode returns over time.

5. Timing of Investment. Based on your Financial Position and your long term or short term financial goals, you should assess if this is a right time for you, financially, to make an investment decision. Jumping into an investment decision just for the sake of it can destroy your hard-earned earnings.

Moreover, you should also consider the timings of the economic cycle. You would need to check whether it is the start, mid or assumed end of a financio-economic cycle as you cannot make investment decisions in isolation from the current market conditions.

Muhammad Khurram Shahzad is a Chief Accountant and a Business Advisor in one of the rapidly expanding IT solution firms in MENA region. He writes on different investment and finance related topics in blogs, articles and other forums.

http://www.financialadviceme.blogspot.com

One year investment bonds can be used to produce a long term capital growth or to generate an income. These bonds are a good way of saving money because they have a fixed rate annually, and the access can be restricted for that period. Before I think of buying the bond, the first thing I would consider is security and whether I can be paid off the bond before maturity date.

Money grows and good returns are produced at the end of the year. To get the investment bond I must pay a minimum deposit and a fixed rate for one year. There is guaranteed returns and the interest is paid annually or monthly. In case I get an emergency, the bank can lend me some of the money although I will have to pay a small charge fee. The money is secure since it is protected and managed by professional investment managers. When compared with stock, the bond does not get much press thus, a better alternative method of investing. If I buy the bonds from the government or municipal bonds, I will enjoy the tax benefits that are quite attractive. It easy to get these investment bonds in the banks or over the internet, and they are commission free.

The best thing is to buy and hold on the bond investment until it matures because I will get paid exactly what I expected. One year investment bonds are safe and highly predictable. I would prefer to buy the bond directly from the government because if I buy through a broker I must pay a commission fee.

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There are many people out there looking to scam people. Therefore it is always important to keep an eye out to make sure it doesn’t happen to you, whether it is protecting against a computer virus or making sure you aren’t the victim to an investment scam.

Everyone wants to make a quick buck if they can, and some use this opportunity to offer investments to people offering quick or easy money. It is therefore very important to be sure of an investment scheme’s credentials before investing your hard earned money.

There are certain signs you should look out for. Any scheme that guarantees a big return is one to be suspicious of. A guaranteed return just isn’t possible as no investment is a certain success.

It is important to fully understand any investment product you are entering into. If you don’t understand then ask. A genuine investment manager will be happy to answer any questions, no matter how silly they may seem to experienced investors; don’t be worried about sounding like you don’t know what you are talking about. If they seem to get agitated or lose confidence in their own answers when questioned, it is probably a bad sign. Some will try to make things seem confusing so you don’t question them. A lack of information is a sign of a scam. Anything you are unsure of, ask.

Some scammers employ high pressure tactics to rush you into a decision. Avoid this at all costs. If you are unsure take your time, and say you will get back to them if you must. If they say it has to be now or never then tell them you are not interested.

It is crucial that you know what you are investing in. If an investment scheme claims to have a positive track record then make sure there is evidence to support this. It is a good idea to contact other investors who have used it in the past. Do some other research as well, for example look online. If they have been successful and people have benefited you may well find information about this. Similarly, if they have scammed people they are likely to have commented about it on blogs or forums. It is also wise to research schemes of a similar nature. For one thing, if it is a scam they may have changed the name or changed certain aspects to try to avoid detection. Most schemes will have something similar through another investment company, whether genuine or not. If you are using an investment company or partaking in investment trusts then make sure the company is registered.

Always urge on the side of caution. If in any doubt at all don’t risk your money. You should never rush into a decision. And if the investment company is trying to force you into rushing then they probably can’t be trusted.

It may sound obvious, but use common sense. If your gut feeling says this may not be trustworthy, walk away, and don’t deal with someone who does not seem professional.

Andrew Marshall (c)

Witan Investment Trusts offer private investors a portfolio of global equities managed by experienced investment managers.

As part of my litigation practice, I represent investors harmed by the misconduct of their stockbroker, investment advisor, or financial planner. Some of these cases can be brought in court; most are required to be arbitrated before the Financial Industry Regulatory Authority (FINRA). In either venue, however, many of these cases have common themes, which teach important lessons about investing.

Wall Street Doesn’t Have a Crystal Ball

The financial industry spends millions of dollars convincing the investing public that it can predict with some accuracy the future price movements stocks. We all know that predicting the future is impossible, but when Wall Street breaks out its technical charts, graphs, and its highly paid analysts discussing “P/E ratios,” “EBIDTA,” “relative strength,” “quantitative analysis,” “momentum plays,” “valuation,” “trading strategies,” “market timing” and the like, it sounds as if they have discovered a window on the future. But the reality is that price movements of stocks are unpredictable and random because stock prices react to news, which by definition is unpredictable and random. The resignation or indictment of a CEO, a product recall, an “earnings disappointment,” the failure of a new product to generate significant sales, or an international crisis all will affect stock prices. These types of events are rarely anticipated and occur randomly. Therefore, contrary to what Wall Street’s very effective marketing would have you believe, those who “beat the market” in the short term do so because of luck, not skill. Academic Research has shown that there is a very low probability — less than 3% — that any one broker, money manager, or investment newsletter can pick investments that consistently outperform benchmark market averages (such as the S&P 500) over long periods of time (10 years or more). Those odds are about the same as the odds of throwing “snake eyes” at a craps table in Vegas. What is the probability that with the money you have to invest today, you can identify the lucky broker, financial advisor, or mutual fund who will consistently roll snake eyes and beat the market for the next 10 or 20 years? Very slight.

Lesson learned: Avoid actively managed investments; stock picking and market timing are losers games.

One Size Doesn’t Fit All.

When you shop for clothes or shoes, there are a variety of sizes and styles because each of us is physically different, and each of us has our own fashion style (or lack of style). Investing choices should also be “tailored” to fit you as an individual. Just as a tailor or shoe salesman measures you before determining what clothes or shoes will fit, a conscientious advisor will similarly “measure” you to determine what types of investments are suitable for you, and how those investments should be allocated in your portfolio to meet your needs, goals and risk tolerance. The advisor should make inquiries to determine your investing time horizon, short and long term liquidity needs, income and savings rate, net worth, tax bracket, and investment experience and knowledge.

Most importantly, the advisor needs to understand what level of risk gives you discomfort. Can you tolerate a decline of 20% in your portfolio without panicking, or do you need to construct a portfolio which, based on historical data, is likely to fluctuate up or down only 5% per year? As a general rule of thumb, more aggressive, risk tolerant investors should be more heavily weighted in small capitalization “value” equities, while conservative, risk adverse investors should be more concentrated in bonds and large capitalization “Blue Chip” securities.

An advisor who takes the time to understand your needs and risk tolerance will recommend diversifying and allocating assets amongst various types of investments consistent with your goals and risk profile. Studies show that over 90% of your investment returns depend on how your assets are allocated among different investment classes, while only about 2% is due to the specific stocks, bonds and other investments you choose to buy.

Lesson learned: An advisor should spend the time to learn your particular circumstances, and tailor investments to fit your own risk tolerance profile. Run, don’t walk, from any advisor who tries to sell you something without first learning about you and your risk tolerance, who has the same solution for everyone, or who recommends putting all your assets into a single type of investment.

Wage War on Fees, Expenses and Commissions.

Over long periods of time (10-20 years), well diversified portfolios have returned approximately 9% per year. Fees, expenses and commissions, imposed year after year, substantially reduce the long-term net investment return. The average expense ratio for actively managed mutual funds is approximately 1.5%. Similar or higher charges are assessed in “managed accounts” or “wrap accounts” where the investor is charged a fixed percentage of the portfolio rather than commissions on each trade. Because of the miracle of compounding, even a small difference in expenses charged against your investments can make a significant difference in the final long term investment results. For example, the final value of an initial $100,000 equity portfolio earning on average 9% a year for 10 years with 1.25% in annual fees and expenses will be $208,754.58. That same portfolio, with identical returns, but with 2% in annual expenses, will be worth $193,439.835, or $15,323.73 less. Additional fees, commissions, and expenses, by themselves, can make it difficult to “beat the market.” As we have seen, there is a high probability that an advisor cannot select investments that beat the market, and the probability of market underperformance is necessarily increased when the account is subject to excessive fees, commissions, and expenses.

Lesson learned: Keep the fees and expenses charged to your portfolio as low as possible. Avoid advisors who are paid on commission.

Don’t Chase Last Year’s or Last Month’s Winners

Mutual funds, Wall Street firms, and financial newsletters love to tout their recent successes. Investors flock to the fund, firm, newsletter, or investment category with the highest recent returns. But what happened in the past is a poor predictor of what will occur in the future. One study suggests that only 14% of the top performing investment managers for a particular year will be among the top performing managers the following year. The same historical reality that applies to stock picking applies to recent “market beating” firms and mutual funds — the fund or firm that did well last year is not likely to repeat that success the next year, and highly unlikely to consistently outpace its peers for long periods.

Lesson learned: Don’t chase recent winners.

Be Leery of Investment “Products” Wall Street loves to sell “investment products.” These come in a variety of forms, including limited partnerships, investment trusts, variable annuities, variable life insurance, mortgage backed securities, and others. Some of these products cobble together investment and insurance concepts in a single package, to be sold as something that will supposedly cure one or another investment risk, or provide a benefit, such as life insurance or a guaranteed return. Often, these products pay the highest commissions to brokers and insurance agents. When I see the phrase “investment product,” my expectation is that I will see an investment loaded with fees and expenses, and which is often too complicated for the average investor to understand. These products are suitable for some people, but are often too costly or complicated to be appropriate for most investors.

Lesson learned: Be leery of “investment products.” Look carefully at the fees and expenses for such products, and if the investment is very complicated, ask yourself whether you should risk your hard-earned money in something you don’t understand.

Make Sure Your Money Lasts as Long as You Do.

In retirement, many baby boomers suddenly will have access to significant lump sums of money, accumulated through savings, pensions, IRA’s, and 401k’s. There is a temptation to spend those assets freely, without considering that those funds may have to last 20, 30 years or more. It is critical for the investor to structure their retirement investments, and any withdrawals from retirement funds, so as not to outlive their money. As a rule of thumb, a withdrawal rate of 4% or less, adjusted for inflation, will increase the chance that there will not be a shortfall. Of course, each investor must consider their life expectancy, the composition of their portfolio, any other sources of funds (such as Social Security or company pensions), and their spending habits.

Lesson learned: The higher the withdrawal rate from your retirement assets, the greater the risk you will outlive your money.

Avoid All the Noise and Invest in Index Funds.

An index fund seeks to match the returns of a specified benchmark by buying representative amounts of each stock in the index, such as the S&P 500 or the Wilshire 5000. Other index funds focus a particular industry, or a particular geographic area, such as the telecommunications or health care sectors, or the leading publicly traded companies of South America or Japan. There are also index funds that track corporate government bond indexes. These funds don’t try to “beat the market,” they “meet the market,” by investing in the securities comprising the benchmark index. As seen, only a small percentage of active money managers beat the market over the long term. That being so, having an investment that “meets the market” year after year is, based on historical data, statistically more likely to provide superior long term returns than active money management trying to “beat the market.” Much of the superior performance of index funds is due to their low expenses, which average.25%, or about 1/5 of the expenses charged by actively managed mutual funds. Additionally, most index funds necessarily provide diversification (e.g., owning the 500 companies in the S&P 500, or the 5000 companies in the Wilshire 5000), and are tax efficient, since there is no active manager trading for short capital gains.

Lesson Learned: Allocate your investments among a variety of national and international equity and bond index funds. A 60/40 portfolio (60% diversified equities, 40% diversified bonds and cash) is generally considered to be a well diversified balanced portfolio of moderate risk. Those seeking more risk should consider increasing their exposure to equities, while those desiring less risk should increase their bond and cash balances. The particular percentages suitable for you must be based on upon your particular risk tolerance, goals, and financial needs.

Robert C. Port is a partner with the Atlanta law firm of Cohen, Goldstein, Port & Gottlieb, LLP, where he practices business and securities litigation. He has a particular emphasis on representing investors harmed by the misconduct of their stockbroker, investment advisor, or insurance agent. Mr. Port has an AV Rating by Martindale Hubbell Law Directory, and has been selected as a “Georgia Super Lawyer” in the practice areas of Business Litigation and Securities Litigation by Atlanta Magazine.

Portfolio optimizer software is a tool used by investment professionals to test the risk and return characteristics of their portfolios on historical data. This article discusses the benefits and myths of these types of tools on real world investment returns.

Mutual fund managers, hedge fund managers, and wealth managers are all judged on the real performance of their managed portfolios over time. This is typically compared to a major benchmark such as the S&P500, MSCI World Index, High Yield Bond Index, or other well-known diversified measure.

The goal is to outperform the benchmark consistently. This can be done by generating the same returns with less risk, greater returns with more risk, or more returns with less risk. The optimum theoretical investment portfolio lies on something called the Efficient Frontier. So how do investment managers build a portfolio that performs at its best?

After picking the best investments, a fund manager will turn to portfolio optimizer software to determine the optimum weightings for each stock, bond, or ETF. Plugging in the list of possible investments and running multiple simulations will output an estimated optimum portfolio based on the historical correlations, volatilities, and returns of each one. The primary benefit of this process is to understand if the portfolio has sufficient diversification. It is easy to accidentally create a portfolio which is highly correlated and vulnerable to market shocks and this simulation analysis is helpful in reducing this danger.

While the process itself is informative, beware that it’s not perfect and can lead to some erroneous assumptions. It’s based on historical data only and tomorrow may not be the same as the past, so today’s portfolio will not be the optimum one for the future. It assumes no transaction costs which is clearly not the case. It assumes perfect information is available in the market which may or may not be true. Finally, it is based on the belief that a major market index is the most appropriate benchmark when many investors may have other drivers such as tax rates, hedging, or a specific investment time horizon.

This short overview of portfolio optimizer software and its common usage should help you determine if this type of tool is right for you.

If you are looking for portfolio optimizer software you can get started with a low price yet sophisticated model right here: http://www.financial-edu.com/portfolio-optimization.php

While meeting with a marketing agency last week I was asked to explain what was different about the way we invest. What is our ‘key point of difference’ compared to, say, your average managed fund. By far the most significant difference is that we don’t use a model portfolio. In this way we also differentiate ourselves from the majority of IMA’s and SMAs (Individually and separately managed accounts) because they also all use model portfolios.

Saying goodbye to the model portfolio

You don’t have to be a fund manager to know that markets go up and down. Yet it seems that many of the supposedly ’smart’ investment managers writing mandates for managed funds have forgotten this key piece of information.

Cash is king, and the key to out-performance

If you invest in a managed fund, and it is mandated to hold X percentage in one sector, and Y percentage in another, and maximum 15% cash, what happens when the whole market falls? What happens if the whole market falls like it did in the GFC? Even the ‘fund manager of the year’ won’t be able to save your investment from declining. Why? Because there is nothing he or she can do, he can’t move the entire portfolio to cash because more than likely he can’t hold more than 15% cash under his mandate and because even if he wanted to the portfolio is too large to liquidate. (the fund manager of the year manages 4.1 billion dollars)

Saying goodbye to the model portfolio allows us to do what other fund managers can’t. Hold 100% cash if we choose, and move in an out of stocks based on opportunities that present themselves. This leads directly to our next point.

The (trading) opportunity of a lifetime comes around twice a week

In the stock market it might actually be more than twice a week if you know where to look. This is why we based our investment ‘model’ on a cash portfolio. All you need to be able to do is be patient enough to wait for the opportunities to come to you, and I assure you, this is harder than is sounds. But if you can be patient and wait for the market to deliver you an opportunity to buy a great company at a great price (typically when no one else wants it) you have greatly increased your chances of profiting from your investment.

Buying when other are selling is tough

By far the hardest part of our trading strategy is buying quality stocks when they are down. This means buying them when other people are selling them. At times this can be a gut wrenching experience.

Understanding the investment and doing your research is key

One of the biggest keys to our success in the market is having a solid understanding of the businesses we invest in by conducting comprehensive research into them before making an investment. The most important function of the research (besides understanding what we are buying) is it helps us be confident enough to buy these companies when they are on sale.

William Shaw is a boutique investment manager which specialises in offering Managed Accounts to private individuals, Self Managed Super Funds and financial planners in Australia. Our Managed Accounts service has outperformed the ASX 200 by 23.32%. For more information, visit Managed Funds

What is “Alpha”?

In investment terminology, “alpha” refers to the level of out performance of a portfolio relative to an appropriate benchmark. Of course, everyone would like to achieve returns in excess of their benchmark. But you’re advised to have a good grasp of the cost and chance of achieving alpha before you decide to chase it.

There are two broad approaches to investment management: active and passive. An active approach seeks to add value, or alpha, by over weighting exposure to securities that are believed to be undervalued and under weighting those believed to be overvalued. The obvious aim is to perform better than a strategy that simply holds all securities according to their market weight (i.e. benchmark portfolio).

Passive investment managers believe that it’s highly improbable that you’ll be able to reliably outperform the benchmark over the long term (without taking more risk). Their focus is therefore not on beating the benchmark but replicating it as cheaply as possible. Their value add is in providing a diversified portfolio with minimal trading and management costs.

Shouldn’t everyone go for “Alpha”?

If you knew that your additional return would more than offset your additional costs, it would always make sense to try to outperform your relevant investment benchmark. However, the difficulty is that while you know the quest for alpha will increase your costs you don’t know for certain that your return will increase. You could end up with the additional costs and worse than benchmark performance (i.e. negative alpha).

In fact, it’s impossible for all active investors to achieve positive alpha. Let’s have a look at an example that illustrates this for the two investment approaches described above.

The small, mythical country of Tinyville has only 4 companies on its stock exchange: Beta, Delta, Gamma and Omega. The values of the companies and their market weightings are shown below for “yesterday” and “today”:

Companies
Passive Investors
Active Investors

Pink
Orange
Blue
White
Black
Brown
Total

Beta Ltd
$14,000
$10,000
$30,000
$25,000
$15,000
$6,000
$100,000

Delta Ltd
$9,800
$7,000
$25,000
$10,200
$8,000
$10,000
$70,000

Gamma Ltd
$7,000
$5,000
$15,000
$7,000
$16,000
$0
$50,000

Omega Ltd
$4,200
$3,000
$10,000
$0
$6,000
$6,800
$30,000

Total
$35,000
$25,000
$80,000
$42,200
$45,000
$22,800
$250,000

Also, there are only six investors in Tinyville: Mr Blue, Mr White, Mr Black, Mr Brown, Mr Pink and Mr Orange. Pink and Orange are passive investors and, therefore, their portfolios will reflect market weightings. The other four are active investors, so their portfolios will differ from the market weightings.

Points to note include:

The total value of the portfolios for all six investors equals (and must always equal) the value of the overall market;

The weighted average return of all investors equals (and must always equal) the market’s total return;

The passive investors earned the market’s return;

The overall weighted average return of the active investors equals the market’s return; and

Black’s outperformance is offset by the underperformance of the other three active investors.

The “Alpha” bet may not be the smartest

The findings from our mythical market apply to real share markets. An active approach is not synonymous with outperformance. In fact, any outperformance by some active investors must be matched by the underperformance of all other active investors.

Many active investors are of the opinion that it’s nave not to try and “beat the market”. They either don’t understand that active management is a zero sum game or, unrealistically, all believe they are better than average investors!

And let’s not forget the certain losses you will incur as a result of the additional costs of being an active investor. Generally, compared with passive investment, they include higher transaction and management costs, early crystallisation of capital gains tax and reduced diversification benefits.

What level of outperformance is required to justify this ongoing drag? Over a 30 year period of share market investment, our estimate is that you would have to generate an additional (risk-adjusted) return of at least 2% p.a. just to breakeven with a passive investment approach. You need to be pretty confident (perhaps, overconfident) of your investment abilities to take this “Alpha” bet!

Wealth Foundations is an independently owned personal financial advisory firm that offers wealth management and strategic financial planning services. For more information, visit Wealth Advisers.

Many wealth managers approach investors positioning themselves as “trusted advisors”. Can you develop this type of relationship with someone who is compensated for selling product, or should you seek out a wealth manager who operates without conflicts of interest between the firm and the client? As more independent advisors arise, this question will present itself more frequently to investors.

One of the biggest complaints investors have is that they feel they are being “steered” towards specific investments by their advisor. Frequently, these products are manufactured and/or managed by the firm that employs the relationship manager. They can take the form of mutual funds, managed accounts, or partnerships. This is true for brokerage firms, investment banks, and trust banks. In many instances, the compensation of the “trusted advisor” is largely impacted by how much proprietary product he or she can sell. With that type of motivation in place, it is fair for investors to ask if their best interests are being placed first.

Some large financial services firms responded to investor’s lack of trust by creating a “platform” that includes a limited number of outside advisors side by side with their own offerings. This is frequently presented in the form of a “wrap” program that entails a large, all-encompassing fee. The wrap fee includes compensation to the investment manager, the advisor, and the advisor’s employer. These layers of fees add up. While convenient, it may prove to be an expensive proposition to the investor. As a result, many investors are gravitating to fee-only independent wealth managers who offer open architecture in a conflict-free manner.

The role of a fee-only advisor is quite different from that of the more traditional relationship between the client and his broker or trust officer. A fee-only wealth manager does not and will not manufacture or sell investment products; their only source of income comes directly from their clients. They will refuse compensation from investment managers, insurance companies, banks, and other sources of investment merchandise. His or her role is to work with you to structure a multi-manager portfolio that fits your specific investment needs. The advisor will likely spend time with you to understand your goals, objectives, and risk tolerance long before the investing process begins. Many fee-only advisors have Certified Financial Planners on staff. These professionals will work with you to ensure that you have the right structure around your assets (i.e. wills, trusts, etc.) to help you meet you your long-term financial goals in the most tax efficient way possible.

It is becoming more difficult for investors to pinpoint outstanding investment talent. There are so many choices that one can become overwhelmed. Fee-only wealth managers offer true open architecture. They are not limited by an investment platform. This enables them to seek out the best and brightest managers in all asset classes. You should expect that your wealth manager has conducted a thorough amount of due diligence on each of the managers in the suggested portfolio. The advisor should suggest separate accounts over mutual funds. Separate accounts are less expensive and more tax efficient than commingled funds. Since your advisor is not compensated for transactions in your account, he or she will probably recommend that your assets be held at a large discount brokerage firm. This will help minimize overall costs to you. While you will be receiving monthly statements from your brokerage firm, the wealth manager should provide consolidated performance reporting on a monthly basis.

To review, here is what individual investors should expect from an independent, fee-only wealth manager:

* A thorough independent appraisal of your current investment portfolio,
* A discussion about what you want to accomplish with your investment capital,
* An examination of the structures around your assets such as wills, trusts, and retirement plans,
* A well-designed asset allocation model that fits your investment goals,
* A suggested multi-manager portfolio that foots with your goals and objectives,
* Thorough and ongoing due diligence on each of the managers in your portfolio,
* Face-to-face meetings at least twice a year to update you on performance and review your objectives,
* A strong effort to reduce investment costs (i.e. manager fees, brokerage commissions, etc.),
* Monthly performance statements,
* No pressure to buy or sell any investment product,
* A fee based upon the amount of assets under advisement.

Fee-only wealth managers offer an attractive alternative to traditional sales-based financial relationships. You have the comfort of knowing that the advisor is working in your best interests and that all recommendations come from a desire to do an excellent job for you.

Copyright 2010 Massey Quick and Co., LLC – All Rights Reserved

Stewart R. Massey is a Founding Partner and the Chief Investment Officer of Massey, Quick and Co., LLC, an investment consulting and wealth advisory firm. Founded in 2004, Massey Quick provides comprehensive wealth management services to high net worth families and individuals and traditional investment consulting services to endowments and foundations. More information is available at http://www.MasseyQuick.com.

There are two main types of accounts that you can have when it comes to purchasing securities. These are active and passive accounts. It is up to you to choose which is right for your investment style and portfolio.

A professional manager can make all the difference in the world in helping you make money and to keep you from loosing a lot of money. You can be your own professional manager, but that requires hard work, education, and time from you. I know a lot of people that use other people as well as do it themselves. It is all who you are and who you want to be. If you don’t want to manage money and have no interest, then you should find a great money manager.

An actively managed account is overseen by an institution who’s investment experts watch your money. They research the top companies that are on the market and offer them to you to invest your money in. Some of these people often trade many times per day, all depending on what you want with your money. You will need to look into the investment managers track record to see that know what they are doing. Interview and sit down with them. Don’t just hand your money over to someone that you think will do a good job. This is money you have worked hard and long for. Look online at sites like MorningStar or Value Line to see reviews of good companies to work with.

A passive management style is very common also. These type of strategies involve a lot of buying and holding. This type of account just needs to be over seen everyday to make sure they don’t keep a loosing stock. Most of these accounts will be based off a particular index that the account manager will want to mirror. If you take the Dow Jones Industrial Average for example. Lets say a fund manager wants to mirror this fund because they think it will be going up. They will most likely buy the DIA or the actual Dow Jones fund to mirror this. It is a very good strategy and can help you make money.

Darius has been writing online for a while now and has a lot of different interests. You can check out some of his websites at http://www.colemanmosquitodeleto.com and http://www.citronellabarkcollar.net