Active vs. passive managers

Amateur investors continue to move money into passively managed funds.  However, according to Ignites Research, elite professionals are largely using actively managed funds, favoring active managers by a ratio of 4 to 1.

What explains this contrarian approach? The answer is risk control. Passively managed funds don’t have the ability to use judgment, being required to continue to match an index no matter what. And as the markets have become increasingly volatile, passive funds are at the mercy of traders who don’t care about fundamental values.

When markets are going up consistently, a case can be made for passive index investing. However, when the market is roiled by rumor and headlines that have little to do with economic fundamentals, passive funds are at the mercy of short term traders. Actively managed funds can take advantage by shopping for bargains. Active managers can raise cash to ride out temporary storms, something that passive funds don’t do.

Amateur investors are attracted to passive investing after years of being sold on low fees and performance claims. However, low fees – measured as fractions of a percent – do little to help the investor watching his or her investments drop by 10, 15, or 20% during bear markets.

And those performance claims assume that the alternative to an index fund is the average of all actively managed funds. This is simply not the case. One leading portfolio manager puts it this way:

“It’s a myth that you can’t find outperforming active managers who can beat their benchmarks over time. So for us, sorting out and tracking the best active fund managers is a worthwhile pursuit and helps add value for our clients.”

We agree. At a time of increased volatility and lowered expectations it’s a good time to get a professional review of your portfolio.

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How a stock market slump affects retirees

Because retirees are no longer earning income, they view a decline in their investments with more concern than those who are still working.

Many savers in retirement also focus on a number that represents the peak value of their portfolio and view any decline from that value with concern.

Psychologists refer to this as the “anchoring effect.”

The unfortunate result of this is that it causes them to worry, leading to bad decisions. This includes selling some – or all – of their stock portfolio and raising cash. This makes it more difficult for their portfolios to regain its previous values, especially when the return on cash-equivalents like money market funds and CDs are at historic lows.

The answer to this dilemma is to create a well-balanced investment portfolio that can take advantage of growing markets and cushions the blow of declining markets.

This is often where an experienced financial advisor (RIA) can help. One who can create diversified portfolios and who can encourage the investor to stick with the plan in both up and down markets.

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Thoughts From Around the Investment World – 3

We thought that our readers would be interested in reading the thoughts of some of the leading money management companies. We get information from these companies on a regular basis, and wanted to start passing some of it along. Today we look at the view from the money management shop Neuberger Berman.

Complex Trends, Challenging Markets

The complexities of today’s markets and economies are not lost on those who spend each day sorting through them. Diverging monetary policy, plummeting energy prices and shifting economies are all examples of fundamentals on which our investment professionals are focused. These issues have been debated for the better part of 2015 and have led to a very turbulent period for the markets, both equity and fixed income. [The] past year [2015] will shape up as one of the more challenging in recent memory.

As we enter 2016, the issues of stagnant global growth, monetary policy and China’s bumpy economic transition that have roiled markets will continue to be a major focus, the outcomes of which will likely drive market returns. We believe the Federal Reserve will take a slow approach to rate increases, that the ECB [European Central Bank] will remain accommodative as necessary, and that China has the financial wherewithal to avoid a severe “hard landing.” As for low commodity prices, they are largely supportive for now, but eventual increases are likely to come for the right reasons, reflecting broader economic health and proper supply/demand balance.

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Types of mutual funds: Traditional Funds vs. ETFs

When people think about traditional mutual funds they typically think about funds known as “open ended funds.” They are the most commons funds. Shares of the fund are bought or sold though the fund company. There are no limits to the number of shares that can be issued and shares prices are determined once a day, after the market closes. At that point the total value of the assets in the mutual fund are determined and divided by the number of shares. This is the “net asset value” (NAV) and everyone who buys a share on that day pays the same price and everyone who sells also gets the same price, not matter what time of the day the order to buy or sell has actually been entered.

“Exchange Traded Funds” (ETFs) are newer but have become popular because they are bought and sold like a stock and are traded on major exchanges. The price of the shares can fluctuate during the day and the price that an investor pays for the shares can be different from minute to minute, just like the price of a stock will fluctuate during the day. That means that an ETF can be bought in the morning and sold in the afternoon for a profit or a loss depending on the change in value. The market price of an ETF is kept near the NAV by large institutional investors who will detect any difference between the NAV and the actual share price and use “arbitrage” to make that difference go away.

Because ETFs are more flexible in terms of trading strategy, they have become very popular with many active investors and speculators. In addition, because many ETFs are “passive” funds they often have lower expense ratios than many traditional mutual funds.

There are a number of other issues that an investor should be aware of with ETFs such as liquidity, commissions to trade, the bid-asked spread, and the viability of any specific ETF.

As always, consult your investment advisor.

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Types of mutual funds: popular types

There are more mutual funds that there are stocks on the NY stock exchange. To make sense of the variety here are some of the most common fund types.

• Money market funds. These are funds that invest in very short term, liquid securities that offer a safe place to put cash. They offer a very low rate of return but try to maintain a net asset value of $1 per share.

• Bond funds invest primarily in fixed income securities. These could be government bonds, corporate bonds, municipal bonds, convertible bonds or mortgage backed securities.

• Stock funds (equity funds) invest primarily in stocks. They are subdivided into many categories according the size of the companies they invest in (large cap, small cap), the investment style (growth, value) and geography (US, Foreign).

• Balanced funds combine the features of stock and bond funds.

• Specialty funds may invest in certain industries (technology, drugs), countries (Britain, Korea) or real estate (REITs).

Well balanced portfolios frequently include funds from many of these categories in proportions appropriate to the risk tolerance of the investor.

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Types of mutual funds: cost structure

Sales Charges
Some funds (load funds) sold by brokers, insurance agents or investment advisors have a front-end sales charge which is paid by the investor and passed along to the seller for his services. The charge is deducted from the amount being invested.

Other mutual funds (no load funds) are offered directly to the investing public by fund companies, or they are offered to investors by financial intermediaries who have a compensation arrangement (hourly, flat fee or a percentage of assets) with the purchaser. In this case, a sales charge is not involved, and the investor fully invests his or her available money into funds sponsored by a no-load fund company.

There are several other arrangement by which load mutual fund companies compensate sales people that are less obvious than front end sales charges in a variety of fund share classes – A, B and C. Many fund families offer special no-load share classes (F-1, F-2) for fee-based advisors who want to use their funds but do not want their clients to pay a sales charge. Before anyone invests in a mutual fund it is important that the investor understands how the broker, salesperson or investment advisor is compensated.

Expense Ratio
A mutual fund’s expense ratio is the amount of money that the fund charges for running the fund. It is usually shown as a percentage of the fund assets. All mutual funds charge investors a fee for their services. In general, passively managed index funds have a lower expense ratio than actively managed funds and bond funds have a lower expense ratio than stock funds.

Redemption Fee
Many mutual funds are charging a fee if the investor withdraws his money from a fund within a certain specified time of making an investment. This is designed to discourage market timing which can complicate the process of managing a fund.

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Wall Street down following Fed comments

From Reuters:

Wall Street dropped on Wednesday after the U.S. Federal Reserve frustrated investors hoping for a strong sign it might scale back future interest rate hikes because of recent financial and economic turmoil.

In a widely expected decision, the Fed kept interest rates unchanged and it said it was “closely monitoring” global economic and financial developments, but it maintained an otherwise upbeat view of the U.S. economy.

This morning Art Cashin predicted :

That, I think, will make them [the Fed] very reluctant to say anything that might look like a full mea culpa or a rethink. Therefore, I think the statement will say they remain flexible and data dependent and that they are aware of crosscurrents. Let’s see if that’s enough to boost the bulls.
Art was absolutely right about the Fed’s announcement but the market didn’t see it as a bullish sign.

 

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Types of mutual funds: passive vs. active

A passive mutual fund invests in a portfolio that mirrors the component of a market index. For example, an S&P 500 index fund is invested in the 500 stocks of Standard & Poor’s 500 Index. There is no attempt made to try to determine which stocks are expected to do well and which are not.

Actively managed funds are managed by an individual manager, co-managers, or a team of managers. The mangers try to buy stocks that they think will outperform the market.

The costs associated with passive investing are lower than the costs of active management. Active managers attempt to justify their higher costs by doing better in either up or down markets.

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What are mutual funds?

A mutual fund is an investment vehicle that is made up of money contributed by many people for the purpose of investing in stocks, bonds, real estate or other kinds of investment vehicles including money market instruments.

Mutual funds are operated by money managers who make the actual investment decisions and who attempt to provide capital gains and income to the investors.

One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital.

When a mutual fund sells a security like a stock or bond, or collects income such as a dividend or interest payment these are passed along to the shareholders of the fund.

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A quick market roundup – January 25, 2016 @ 10:00 AM

The U.S. eastern seaboard is still digging out from a weekend blizzard that knocked out power for several hundred thousand customers, grounded more than 13K flights, and shattered snowfall records in Washington and New York City.

Oil and stocks are heading lower this morning on oversupply concerns and profit taking after Friday’s surge in prices. Iran has made its first sale after sanctions were lifted and Iraq’s production is up while the Saudis are continuing to invest in new production.

McDonald’s Corp reported better-than-expected quarterly same-restaurant sales as the launch of all-day breakfasts proved to be a hit with diners in the United States and demand continued to recover in China. The company plans to open more than 60 new stores in Russia 2016.

Russia’s economy contracted the most since 2009 last year as the price of oil sank and sanctions over the conflict in Ukraine curbed access to international financing. According to preliminary estimates, gross domestic product fell 3.7% after growth of 0.6% in 2014.

Johnson Controls and Tyco International are in advanced talks to merge, in a deal that could value the latter as high as $20B and signal that companies are still willing to embark on large mergers despite the recent market volatility. The combined company would be headquartered in Ireland.

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