Widor & Respighi

 

Widor and Respighi

 

This week I am recommending another classical piece, but something a little different from the usual classics. This Hyperion CD includes Charles-Marie Widor's Symphony No. 5 in F Minor, Mystique Op. 87 and March Pontificale from the first symphony. If you do not like organ music, pass on this recommendation. While I am not a huge fan of the organ I do make an exception for certain parts of this CD. Look around on Amazon and see if you can find these pieces on a CD with higher recommendations.

Since Widor may be at one extreme of your classical listening tastes, I am including another CD recommendation and it is Ottorino Respighi's Pines of Rome, The Birds, and Fountains of Rome. This Telarc CD features the Atlanta Symphony Orchestra conducted by Louis Lane. Pines of Rome etc. is a "must have" in any classical library.

 

Photograph: Bryce Canyon, Utah – USA

Portfolio Performance – 27 August 2010

While this was not a particularly strong week for the broad market, the six (Curie, Newton, Schrodinger, Einstein, Kepler & Bohr) portfolios I updated this week performed better than expected. In general, the six portfolios showed improvement in both the Sortino and ITA ratios. Due to broad diversification, most of the six picked up ground on the broad market as measured by the VTSMX benchmark.

To learn more about the Sortino and ITA ratios, do a search for each on this blog.

Portfolio Performance - 8/27/2010

Portfolio Last Update Launch Date Tracking Tool Port. IRR ITA Index Diff Port. vs. ITA Index VTSMX IRR Diff. Port. vs. VTSMX Index IR SR ITA Ratio
AA-Mosaic 07/30/2010 07/21/1999 Captool 1.61% NA NA -0.43% 2.04% 0.05 NA NA
Curie 08/27/2010 12/26/2007 TLH SS 0.3% -11.6% 10.7% -8.0% 8.3% NA 12.0* -1.22*
Mosaic2 07/30/2010 07/19/1999 Captool 4.1% NA NA -0.62% 4.7% 0.15 NA NA
Newton 08/27/2010 06/02/2008 TLH SS 4.6% -1.1% 5.7% -1.7% 6.3% NA 16.0* 3.84*
Passive Port. 07/30/2010 12/01/2000 Captool 4.5% NA NA 0.02% 4.4% 0.68 NA NA
Schrodinger 08/27/2010 12/01/2000 TLH SS 4.3% 6.0% -1.7% 0.5% 3.8% NA 5.7 4.8
Jane 07/30/2010 02/14/1997 Captool 8.3% NA NA 3.11% 5.19% 0.53 NA NA
Einstein 08/27/2010 06/30/2008 TLH SS 8.8% 15.8% -7.0% 2.0% 6.8% NA 7.3* 6.1*
Gauss 07/30/2010 02/19/1997 Captool 8.62% NA NA 3.1% 5.5% 0.22 NA NA
Kepler 08/27/2010 11/01/2008 TLH SS 18.3% 27.1% -8.8% 12.2% 6.1% NA 5.5* 5.5*
Scrappy 07/30/2010 08/14/2008 Captool 9.24% NA NA -4.47% 13.71% 0.77 NA NA
Bohr 08/27/2010 08/14/2008 TLH SS 7.5% 7.7% -0.2% -4.7% 12.2% NA 15.3* 5.5*
Projects 07/30/2010 12/01/2000 Captool 4.7% NA NA 0.02% 4.62% 1.34 NA NA
Washington 07/30/2010 06/18/1999 Captool 2.77% NA NA -0.19% 2.96% 0.27 NA NA
Maxwell 08/20/2010 12/25/2000 TLH SS -0.5% -1.6% 1.1% 1.4% -1.9% NA -1.0 -1.3*
Adams 07/30/2010 06/18/1999 Captool 2.53% NA NA -0.19% 2.72% 0.70 NA NA
Euclid 08/20/2010 06/30/1999 TLH SS -0.7% -1.3% 0.6% 1.3% -2.0% NA -0.8 -1.2*
Jefferson 07/30/2010 03/13/2008 Captool 5.15% NA NA -3.88% 9.03% 0.30 NA NA
Madison 08/20/2010 03/13/2008 TLH SS 4.3% -1.9% 6.2% 1.4% 2.9% NA 4.2* 1.8*

Portfolio Changes

This morning I walked through the Strategic Asset Allocations for each portfolio and lowered the bond allocation to something close to 10% in each portfolio. The reason for making this Tactical Asset Allocation change is tied to my concern interest rates will rise. With rates as low as they are, the probability of them going lower is very low as they are not going below 0%. It makes sense to push the allocation down to a minimum percentage. In taxable accounts it may be prudent to sell all bond and income holdings with exception of TIP. [Read more…]

Avoiding Losses

How does one avoid major losses to the portfolio? Here are the two simple Faber – Richardson rules.

[Read more…]

Brahms & Schubert

 

Brahms & Schubert

 

The Academic Festival Overture Op. 80 and Alto Rhapsody Op. 53 by Johannes Brahms plus Franz Schubert's Symphony No. 9 "The Great C Major" are on this EMI CD. Sir Adrian Boult conducts the London Philharmonic Orchestra. Brahms Alto Rhapsody is worth the price of this CD, hence my recommendation for the week.

To quote one Amazon reviewer, "The main event on this CD is the Schubert Ninth, but the outstanding performance on it is the Brahms Alto Rhapsody with Janet Baker in her prime. Her fervent, glowing singing has been matched only by Ferrier and Ludwig in this work, and Boult's quick tempo combined with excellent choral work, makes this a must-listen."

 

Photograph: Near the entrance of The Arches National Park, Utah – USA

Avoid Losses

There is nothing quite so painful to the long-term investor as watching their portfolio experience a long and precipitous decline. Most of us experienced this in 2000 through 2002 and again in 2008 and early 2009. Diversification did not help all that much in the recent severe bear market. Asset allocation, no matter how carefully designed, did not perform as we expected. All asset classes seemed to be highly correlated in the horrendous market of 2008. What can be done to protect against losing money? As Warren Buffett succinctly stated, "The first rule is not to lose. The second rule is not to forget the first rule."

The only way to prevent losses is to come up with some sort of timing model, "sinful" as that may sound. We can use the academic term, Tactical Asset Allocation (TAA), but regardless of what we call it, fighting bear markets drives us away from a totally passive approach to investing. [Read more…]

Portfolio Performance – 20 August 2010

For some reason, I expected to see greater decline in the Internal Rate of Return (IRR) values this week.  In a number of cases, the portfolios picked up a little ground on the performance of the VTSMX. Obviously, this is due to the broad diversity of the asset classes held in the portfolios. In a few cases, the ITA Index increased significantly and that is due to the addition of International REITs added as an asset class. The IRR of RWX did well since the addition. Never fear, this will smooth out over time and the IRR for the ITA Index will retreat.

SR is the Sortino ratio and ITA ratio is our latest addition to the TLH spreadsheet. The ITA ratio is a combination of the Sortino ratio as it is currently defined and the following equation.

R = (P – B)/DR where

R is the second risk factor calculated using.

P = IRR of Portfolio.

B = IRR of Benchmark where we are currently using the VTSMX index.

DR = Downside Risk or the semi-variance calculation for portfolio volatility.

When you see the * symbol, that indicates we do not have 36 data points or three years of information on which to base the calculation.

All these calculations can be found in the SR worksheet of the TLH spreadsheet and they make more sense when seen in equation form.

 

Portfolio Performance - 8/20/2010

Portfolio Last Update Launch Date Tracking Tool Port. IRR ITA Index Diff Port. vs. ITA Index VTSMX IRR Diff. Port. vs. VTSMX Index IR SR ITA Ratio
AA-Mosaic 07/30/2010 07/21/1999 Captool 1.61% NA NA -0.43% 2.04% 0.05 NA NA
Curie 08/20/2010 12/26/2007 TLH SS 0.3% -10.3% 10.6% -7.2% 7.5% NA 10.9* -1.11*
Mosaic2 07/30/2010 07/19/1999 Captool 4.1% NA NA -0.62% 4.7% 0.15 NA NA
Newton 08/20/2010 06/02/2008 TLH SS 4.7% -0.1% 4.8% -0.6% 5.4% NA 13.5* 4.1*
Passive Port. 07/30/2010 12/01/2000 Captool 4.5% NA NA 0.02% 4.4% 0.68 NA NA
Schrodinger 08/20/2010 12/01/2000 TLH SS 4.2% 6.2% -2.0% 0.8% 3.4% NA 5.2 4.7
Jane 07/30/2010 02/14/1997 Captool 8.3% NA NA 3.11% 5.19% 0.53 NA NA
Einstein 08/20/2010 06/30/2008 TLH SS 8.9% 15.2% -6.3% 3.2% 5.6% NA 6.0* 6.0*
Gauss 07/30/2010 02/19/1997 Captool 8.62% NA NA 3.1% 5.5% 0.22 NA NA
Kepler 08/20/2010 11/01/2008 TLH SS 18.3% 26.7% -8.4% 13.8% 4.5% NA 4.1* 4.1*
Scrappy 07/30/2010 08/14/2008 Captool 9.24% NA NA -4.47% 13.71% 0.77 NA NA
Bohr 08/20/2010 08/14/2008 TLH SS 7.6% 8.1% -0.5% -3.6% 16.2% NA 14.0* 5.6*
Projects 07/30/2010 12/01/2000 Captool 4.7% NA NA 0.02% 4.62% 1.34 NA NA
Washington 07/30/2010 06/18/1999 Captool 2.77% NA NA -0.19% 2.96% 0.27 NA NA
Maxwell 08/20/2010 12/25/2000 TLH SS -0.5% -1.6% 1.1% 1.4% -1.9% NA -1.0 -1.3*
Adams 07/30/2010 06/18/1999 Captool 2.53% NA NA -0.19% 2.72% 0.70 NA NA
Euclid 08/20/2010 06/30/1999 TLH SS -0.7% -1.3% 0.6% 1.3% -2.0% NA -0.8 -1.2*
Jefferson 07/30/2010 03/13/2008 Captool 5.15% NA NA -3.88% 9.03% 0.30 NA NA
Madison 08/20/2010 03/13/2008 TLH SS 4.3% -1.9% 6.2% 1.4% 2.9% NA 4.2* 1.8*

 

Overall, these nine portfolios are performing very well when measured against Vanguard's Total Market Index Fund, the VTSMX.

 

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Harry Markowitz

 

Modern Portfolio Theory

This morning I came across an interesting article on Harry Markowitz, the father of Modern Portfolio Theory (MPT).  Early in "The Big Bang" article are the fundamental principles of MPT. Quoting from the article, here are the three basic investment techniques or ideas that come out of MPT.

"Those techniques are based on three foundational concepts: asset allocation, mean variance analysis and the optimized portfolio. Markowitz, a 1990 Nobel laureate and adjunct professor of finance at the University of California, San Diego, first introduced the idea of MPT in 1952-when he published his paper, "Portfolio Selection," which posited that investors should consider a security's impact on the entire portfolio, and not its singular merits alone.

Markowitz also developed a quantitative process, called mean variance analysis, to help investors figure out how to choose the most complementary securities for a portfolio. It calls for analysts to estimate the portfolio components' future returns, correlations and standard deviations, which are then combined to derive an optimal balance of risk and return. That move alone made the portfolio construction process more quantitative and seemingly, more objective (although it is based on projections, which can be flawed, as critics point out). The mathematical model is so enduring that all financial planners who sit for the certified financial planner certification (CFP) exam have to learn it.

Finally, Markowitz introduced the concept of an optimized portfolio, the idea that investments can and should reflect the best balance of risks and rewards for clients, given the current investing environment, their risk tolerance and their financial circumstances. "That is his genius idea, the secret sauce of MPT," says Ken Solow, founding partner and chief investment officer at Columbia, Md.-based Pinnacle Investment Group. "The idea that there is an efficient frontier, an efficient portfolio-we are never going to get past that."

As I was reading over this article, I asked myself, am I applying the techniques or principles of MPT? There is no question as to whether or not asset allocation principles are applied in the construction of our portfolios. Asset allocation is at the core of all portfolios tracked here at ITA Wealth Management.

The second principle, mean-variance analysis, is not quite so simple to answer. Any theory with as many variables as investing is bound to see revisions after nearly sixty years of operation. MPT has its critics and efforts are under way to improve the theory.  Mean-variance is one of the key principles that has undergone change. We recently made the switch from mean-variance to semi-variance for all the reasons written about in past blogs. Even Markowitz, back in the 1950's, recommended using semi-variance, but the computing power was either insufficient or too expensive so the easier calculation, standard deviation (SD) was used. SD is now so ingrained in all the models it is difficult to lever it out of its prominent place and replace it with a superior risk calculation, semi-variance. The Post Modern Portfolio Theory (PMPT) group is working to replace mean-variance with semi-variance. It makes good sense to migrate from mean-variance to semi-variance. Mean-variance penalizes the money manager when the portfolio exhibits volatility to the upside as well as the downside. Since we want volatility to the upside, it makes little sense to fault the investor when the portfolio is making money. Our concern is with volatility to the downside. This is where the semi-variance calculation trumps mean-variance. In summary, we are applying Markowitz's principle of volatility, only we are using his recommendation of more than 50 years ago rather than the standard deviation calculation. Actually, the TLH spreadsheet includes both calculations. In addition, we recently move the portfolio risk bar higher with the addition of the IRA Ratio.

The last of the three principles is optimization. I have a "pure" optimization program on my computer, but I no longer use it for several reasons. If one applies no constraints to the various asset classes, the software will recommend Strategic Asset Allocation plans no one in their right mind would use as a portfolio plan. It is truly an example of "garbage in – garbage out." When one applies constraints to the Mean Variance Optimization (MVO) software, the user is forcing the portfolio to look much like what we set up without benefit of the MVO software. Instead of using a MVO software program, we use the Quantext Portfolio Planner (QPP) software as a guide in helping us understand the relationship between projected return and projected risk. Yes, the risk is a mean-variance calculation, but we can live with standard deviation for these purposes.

In summary, we are applying the principles of MPT in our efforts to construct profitable portfolios. This is not all we do in the process of portfolio construction, maintenance, and monitoring, but the basics are in place. The published Portfolio Performance data tables show how well we are performing with our policies.

 

Photograph: Image captured at the Hagia Sophia in Istanbul, Turkey.

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Hedgehog or Fox Investor?

Do you fall into the hedgehog or fox style of thinking, and how does it impact your investing methods? (The fox knows many things, but the hedgehog knows one big thing.”) Think about this for a moment before answering.

Maybe we are all a little bit of both, but lean more to one side than the other in our thinking processes. As a Mosaic Investor, I like to think of myself as a “fox thinker,” but due to an obstinate nature, particularly when it comes to facts, — well, I might be tugged over to the hedgehog side of the thinking spectrum on occasion.

A “hedgehog investor” is one who knows a method of investing (a big idea) and will stick with it regardless of any evidence suggesting they might be wrong, or at least misinformed. “Hedgehog investors” are reluctant to break with their “big idea” or examine their methods when questions are raised as to its validity. In many cases, it is the lack of evidence supporting the investing method that should raise the flag of warning.

Let’s use an example I followed back in the 1970s and into the 1980s. To my knowledge, this investing method is no longer used so no harm should come to any readers. This timing model was followed by so many investors at the time that a signal to move in or out of the market actually had an impact on the broad U.S. stock market.

The timing model used no-load mutual funds that permitted one to trade over the telephone. Remember, no Internet was available to T.C. PITS at the time. Here were the trading signals. When one was out of the market, you were to remain in cash until the 200-Day Moving Averages for both the NYSE (It might have been the DJI) and the Dow Jones Transportation averages moved from below to above the 200-Day simple moving average. When both averages were positive, one moved all cash into the no-load mutual funds of choice. The service also included mutual fund recommendations. The investor stayed in the market until both the NYSE and DJT averages moved from above to below their 200-Day Moving Averages. These were not Exponential Moving Averages (EMA), but simple moving averages. Even though the trading rules were clearly explained, if one did not want to do this on their own, we were welcome to turn our money over to this advisor at a cost of 3% of the portfolio value. I considered a 3% fee for this service to be usury.

Please note – I am not an advocate of the above timing model.

Here we have a “big idea” or a hedgehog approach to investing. Now if one applied a little “fox thinking” one could outsmart this well known investment advice by using Exponential Moving Averages (EMAs) instead of Simple Moving Averages (SMAs). Remember, EMAs are faster moving averages compared to SMAs. Using EMAs one would exit and enter the market a few days before the timing advisor gave his buy or sell signal, thereby avoiding the market move when this “hedgehog advisor” gave his signal. On one occasion, this advanced warning resulted in avoiding a 22% single day drop in the market. Does anyone remember “Black Monday” back in October of 1987?

Without getting too specific, there are still “hedgehog thinkers” working the marketing system without providing evidence their investment advice actually works, and by works, one generally means the investing method will perform better than a benchmark. The S&P 500 is one of the most used equities benchmarks in this country so one expects a portfolio will outshine the S&P 500.

A “fox investor” is constantly taking in new information, particularly research that breaks new ground. The "fox investor" also has a reliable method for determining portfolio performance and portfolio risk. These two important measuring instruments are wrapped into one important ratio — the Sortino ratio. It is unfortunate this ratio does not carry a more descriptive name, but we will go with the common usage.

Perhaps it is a bit of the “hedgehog” in me, but I think asset allocation (AA) is really a “fox” or even “foxy” approach to investing. Combine AA with some technical analysis, tactical asset allocation, mix in QPP analysis and one begins to put together an investing model that can be shown to reduce risk while improving performance. And that is what it is all about.

 

Photograph: Tulips in South Burlingame, OR

Pros and Cons of Index Investing

While scanning the Internet, I ran into this interesting post on the pros and cons of index investing. The writer covers many points we attempt to combat through our approach to portfolio construction and asset allocation. The author chides index investors for being too complacent.  We are anything but complacent and one way we avoid this problem is to accurately maintain and monitor portfolios through the use of the TLH spreadsheet. This systematic monitoring keeps us on our toes. A sample spreadsheet is now available under Blogrolls.

"The second thing I don’t like about index investing is that the conventional indexing approach does not permit consideration of the effects of changes in valuation levels."

I don't place a lot of stock in the second thing the author does not like about indexing.  Yet there is a point to consider when buying and selling index investments. We use ETFs as our index vehicles of choice as I reason this provides the advantage of being able to place limit orders. One cannot do that with the standard index mutual fund. We do have a method of hedging the portfolio when it becomes overvalued. While we have little historical data with our methods, we expect to gain more experience over the next few years as it appears we will, to use a sailing term, be "in irons" more often than not.

Unfortunately, I was not able to find the date when this was article was written. The information is worthwhile and I highly recommend the article.

 

Photograph: Welcome to Istanbul, Turkey

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