Thursday, March 20, 2014

Has Investing Reached a Fork in the Road?

Within living memory, investing has evolved in three stages:

 Stock selection was the key after World War II. Fifty years ago Shearson boasted of its stock-picking
task force: "Last year they traveled more than 350,000 miles, studied more than 10,400 annual reports and held more than 5,400 interviews with company executives."

Then efficient market theory came along. All that analytical work, it seemed, was pointless. On average, stock pickers produced only average results. And that was before commissions.

Asset Allocation reflected the finding that investment returns depended mainly on how funds were deployed among different asset classes. Selection of  specific securities was secondary. Thanks to index funds, followed by similar ETFs, asset allocation became simple, efficient … and deadly dull.

Efforts to spice up AA by creating dozens of asset sub-classes ("I'm tweaking my Chinese midcaps and dumping Irish micros.") didn't help much.

Irregular Investments – less alliteratively, alternative investments – avoid the shortcomings of both SS and AA. Markets are less efficient in the II world, and private equity deals appeal to investors who want to feel they've entered the big leagues.

"Hedge funds, private equity, and private debt are being extolled as some of the best ideas for wealthy investors' portfolios in 2014," according to this Barron's cover story. (I gained access; results for other nonsubscribers may vary.) As shown here, Goldman Sachs is putting 14% of clients' money into private equity. GenSpring puts a full quarter of client assets into hedge funds.
As an investment method for the 1%, irregular or alternative assets are winners. Clients feel special. Wealth managers harvest hefty fees. But for lesser investors, a competing approach is gaining ground.

Cost Control. Even if most funds and portfolios typically produce more or less average returns, investors can gain a sure-fire edge by lowering their costs. Jack Bogle, of Vanguard fame, has proselytized for cost control for years. His latest salvo: The Arithmetic of “All-In” Investment Expenses.

Even one-percenters can be tightwads when confronted by today's investment fees. Stuart Lucas, for example, believes investors should focus on what they net after expenses and taxes.
Stuart E. Lucas, chairman of Wealth Strategist Partners, which manages about $1 billion for a small number of wealthy families, analyzed state and federal taxes along with management fees to argue that if 50 percent of your return went to someone else, then you should reconsider the investment.
Index funds and most mutual funds are under the 50 percent line. Hedge funds are always above it for a taxpaying individual. Private equity investments are on the line.
 Will pricey Irregular Investments prevail as hedge funds seek to expand their customer base beyond the 1%?  Or will the 1% decide hedge funds are so yesterday and boost their returns by cutting expenses? We'll be watching.

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