“Creme List” – 24 June 2011

Twenty stocks made the "Creme List" this week.  There were no new-comers and no stocks were purged from the list.  That will happen in a few weeks if some companies do not make a comeback.  Examine the "Creme List" for stocks of interest.  Note that only one is priced to purchase despite the market decline this week.

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Portfolio Construction: Asset Allocation Percentages Are Vital To Success

 Photograph: Fisherman in Greek Islands


This Blog is dedicated to helping the beginning investor build and monitor a portfolio.  Here are a few of the basic guidelines.

  • Skew the portfolio toward small-cap ETFs and play down large-cap ETFs.  Evidence for this shows up in the Portfolio Performance data tables.
  • Emphasize value over growth as value outperforms growth over the long run.
  • Diversify into emerging markets, REITs, bonds, and developed international countries.
  • Pay rapt attention to portfolio diversification as the structure of asset allocation is one of the more important decision you will make.

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Fama & French – Value Risk Factor


Sculpture on Main Sacred Way to Ming Tombs

Fama-French’s value risk factor is at the heart of their paper, The Cross-Section of Expected Stock ReturnsThis link connects you to an abstract of their paper.  It takes someone like William Bernstein to explain the research study and its importance.  Let me quote from "The Intelligent Asset Allocator."  The first sentence below refers to some tables in his book.

"Most readers will recognize the high-yielding (cheap) group as 'terrible' companies, and the low-yielding (expensive) as 'good' companies.  Probably the most impressive work in this area was done by Professors Fama and French, published in the Journal of Finance in June 1992.  They exhaustively studied stock returns from July 1963 through December 1990 and found that all of the variation in return among stocks could be explained by just two factors: company size (no surprise here) and P/B. [P/B is Price/Book/Share]  They divided their stock database into 10 groups ranging from the lowest P/B (cheapest) to the highest P/B (most expensive). The cheapest one-tenth of the market returned 19.6% annually, and the most expensive tenth, 7.7% annually.  The smallest cheapest stocks returned 23% annually. They also found P/E useful, but not nearly as useful as P/B. After taking P/B into consideration, P/E has no predictive value."

The FF study demonstrates that value stocks have had higher returns than the broad market. Value is determined in the F-F study by the Price/Book ratio. Cheap stocks outperform expensive stocks, and by cheap we mean stocks with a low P/B ratio.

Ferri writes, “Like the size factor the value factor cannot be diversified away by adding more value stocks; hence, value has its own unique risk factor.”

Once more, to enhance the performance of the portfolio, increase the percentage of equities in the mid- and small- value asset classes. The data I have going back to 1989 also supports this thesis.

Speaking in ETF terms, over-weight VBR compared to VBK and hold a higher percentage of VOE vs. VOT.  I know one investor who will use mid- and small-cap core holdings (VO and VB) instead of VOT and VBK.  This is another way to skew or tilt the portfolio toward the value side of the investing spectrum.

Here is a great quote from Bernstein that sums up this blog post.  "Good companies are generally bad stocks, and bad companies are generally good stocks."

This is the type of research we use when building our portfolios and I think this is one of the reasons we perform quite well vs. the benchmarks as Vanguard's Total Market Index Fund, the VTSMX.


Portfolio Construction: The Important Decisions

William J. Bernstein, in his most recent book, “The Investor’s Manifesto” writes, “Before diving into the most important issue faced by any investor–the asset allocation decision–you will need to understand four things: save as much as you can, make sure you have enough liquid taxable assets for emergencies, diversify widely, and do so with passive or index funds.“

If you are not a saver, it is questionable how much useful information you will derive from this blog, ITA Wealth Management. Perhaps I can persuade or scare you into saving more than you ever thought possible. This blog is also about diversification and using index funds or index ETFs. My persuasion is to use index funds for smaller portfolios and ETFs for larger portfolios. If one can hold commissions to something below 50 basis points per transaction, then I favor ETFs.  It is now possible, through TDAmeritrade, to populate a well-diversified portfolio with commission free ETFs. Drive costs lower as it works to the bottom line. And now to that most important investment decision — one of asset allocation. The first decision, and the most important according to available research, is to determine the stock/bond ratio. Will it be a 50/50 or a 90/10 ratio? This decision is unique for each investor, and to help with this determination, once more I direct investors over to http://www.ifa.com for the Risk Capacity Survey. If you have not already done so, take this survey to see where you fit on the stock/bond continuum. The next asset allocation step is even more difficult as one now needs to decide what asset classes will make up the stock portion of the portfolio and what bonds to use for the bond portion. A lot of attention is given to these decisions here on the Platinum level of ITA Wealth Management.  Once the different asset classes are identified, investors are ready for the last decision and that is — what percentage should be allocated to each asset class? For example, if 40% is allocated to bonds do you place all 40% in BND or is it better to divide bonds into four different bond ETFs such as TIP, HYG, BIV, and BND, or some other combination of different ETFs? This is were we rely on some correlation analysis, particularly when it comes to the different stock asset classes. Again, this analysis requires a little more effort using Quantext Portfolio Planner (QPP) and other resources.

Platinum members have access to several portfolios on this blog and this includes all the trades, few though they are, and the asset allocation plans.  New members can watch the development of the Kenilworth Portfolio, a young portfolio that is just beginning to grow.

Platinum membership is available for $5.00 per month.  You will make that back by following the examples shown here at ITA.