Category Archives: Finance

The Bubble In Indexing?

Seems like there are lot of opinions on the increased popularity of indexing, so I will add one more to the mix.

I think indexing will continue to increase in popularity until it stops working.  What does stop working mean? It means when the average market performance is down (for a period of time longer than two weeks).

Sure, everyone likes indexing when the average performance is up.  Or significantly up. Folks don’t feel bad about being average, because of their low cost, low effort strategy. Plus there are news stories about how their strategy is beating some smart hedge funder to make them feel good.

I’m guessing that they’re not going to care about how low cost their strategy is if the average market performance is a loss.  Average will become unacceptable. They won’t feel smart.

And then there will be news stories about investors who aren’t average, who didn’t lose money. At that point, investors will be start looking for other strategies.

To be clear, I am not predicting market losses. I’m just saying that it’s going to take sustained market losses across broad asset classes to create an inflection point in the current index investing trends.

Also, this is not a referendum on the effectiveness of indexing investing. In all likelihood, it’s the the most optimal strategy over the long run for the vast majority of investors out there. Is your thesis really based on most investors doing what’s optimal at all times? Since when has that happened?

That’s my two cents…

It’s felt pretty good, on average, to invest in *anything* the last three years….

Current Sentiment

“Predicting the future is harder than misremembering the past.” – Cliff Asness

I learned a long time ago (the hard way), not to give people investment advice.  However, I will share what I am thinking and doing. Before I discuss any specific thoughts or observations, let me provide some background for context.

First Do No Harm. Conservative.  Arguably overly conservative.  I sort of take the Hippocratic Oath of Investing: first lose no money.  And please don’t risk money you need, for money you don’t.

Boring Is Fine.  I’m ok with boring.  There are no style points in my book. I’m not looking to impress anyone.  I don’t plan to get rich quick through my saving and investing.  Short term opportunities may come my way, but I am certainly not looking for them.

Patience.  This might be my only advantage in investing.  I have no annual reporting requirements. I do not earn a year end bonus based on my investing performance.  I do not have fund life issues or investor withdrawals to worry about.

Source of Income.  My main source of income is my job.  That’s not going to change any time soon.  I count on consistently adding more money to my savings by saving current income than by growing my savings through investing returns.  So I plan to earn my way to retirement. I am not a professional investor. That’s not how I make my money. Important distinction.

Bubbles.  Much of my experiences have been heavily influenced by bubbles. I worked for a software company from 1999 – 2003.  I moved to San Francisco in 2000. After business school, I joined an investment bank in 2005 and worked there through 2010.  I bought a house in 2005 in Baltimore – which thankfully I was forced to sell in 2006 due to a corporate move. Now I work for a private equity-backed business…uh oh. (more on that later).

Fixed Income Guy.  This is a chicken and egg problem.  Not sure if fixed income appeals to me because of my personality, or my personality is a good fit for fixed income.  Let’s just say my weightings toward fixed income would not align with the allocations of any Target Date funds for my age bracket.  

Trend Watching

There’s been a pretty dramatic shift in interest rate expectations in the last 90 days.

There were some pretty large movements in a few areas I was watching at the end of 2018.  And I totally failed to pull the trigger on any of them. We will see if that was a short-term miss or something I’m going to regret at the end of the year.  To be fair, I did add a small position of NTG into one account.

When you look up “v shaped recovery”, these pictures show up.

Nuveen Pref & Income Opps Fund:JPC

Source: CEFConnect.com

Tortoise MLP Fund:NTG

U.S. equity markets have produced much better returns than markets outside the U.S. for a fairly prolonged period.  I’m just not that eager to put a lot of money to work in U.S. equity markets at the moment given how far they have come, the duration of the economic cycle, and with so much geo-political uncertainty.  

Source: MarketWatch

Rate expectations are impacting currency trends.  This is probably a blinding glimpse of the obvious.

Source: MarketWatch

Current Thoughts:

Certificates of Deposit (CDs).  Yep, boring.  But patiently conservative.  Principal protection. FDIC insured presuming you stay under the limits of any one institution.  Rates (https://www.bankrate.com/cd.aspx) on par or better than comparable treasuries.

Before you stop reading, go ahead and take a look at this chart:

Source: CapitalSpectator.com

I’ve made purchases of CDs through my brokerage account as well as directly at a couple online banking institutions.  We sold my prior business in May 2017 and a good portion of those funds went into CDs and money market funds. Then, we sold our house in Sept 2018 when we moved, and much of those funds went into CDs as well.

Source: Fidelity

Historically, Treasuries would be considered to have an advantage over CDs as a diversifier to equities.  Bonds historically have moved inversely to equities. With correlation so strong across markets these days, some of that argument seems to be losing its basis.

Side note: Looking at this chart, someone would have to explain to me why any investor would want to take on the credit risk associated with the corporate market at the moment for very similar yields?  I always keep an eye on senior loans. They have a special place in my heart. Some of what I am seeing in the market as well as direct experience in my business has similar hallmarks of the 2005 – 2007 period. For those of you who may not remember, that period was followed by some slight under performance.

I-Bonds.  Yep, boring. There is really no one with any incentive to sell these to you, so they fly under the radar.  These are purchased through the Treasury, offer competitive rates, are inflation protected (with a floor), and interest is deferred and potentially exempt. Note, annual purchases are limited and there is a small early withdrawal penalty.

Source. TreasuryDirect.gov

I need to make my annual purchases for me and Mrs. SFTE.

Taxable Munis.  Exciting, no sorry, boring.  Probably a lesser known world of the municipal market.  I like traditional municipals as well, but take a look at this space.  This space got more attention several years ago with the Build America Bond (BABs) program that expired in 2010.  It’s still can be an attractive space, when paired with a tax efficient strategy (i.e., holding in a tax advantaged retirement account).

Given that the supply of BABs was shrinking, some BAB-specific fund have altered their mandates recently.

Nuveen Taxable Muni Income:NBB

Source: CEFConnect.com

Side note: I have an affinity for Closed End Funds (CEFs).  Must be another personality quirk.

International.  Oh my, getting crazy.   Focused here on reducing home country bias, investing in sectors with lower valuation multiples than U.S. markets, and potentially getting some tailwinds from currency movements now that rate hike expectations for the U.S. are declining.  Good article here. Since my tendencies are to be (overly) conservative, I use my automated 401k contributions to ensure that I am going to put some dollars to work here.

Value Portfolio.  In full disclosure, I also manage an account focused on individual equity positions.  Generally, I hold 8 – 10 positions that are focused on what I call “value”. I use an ROIC screen plus business and financial analysis.  Interesting ideas have been hard to find here. I’ve been working on sizing positions better. Reviewing the returns on this portfolio is a good reminder of how hard investing really is.  But I enjoy the process and it keeps me engaged. I’m also not 100% bought into passive investing.

“As sure as night follows day, passive is going out of favor.” – Jeffrey Gundlach

Summary

It’s certainly an environment that makes me shade even more conservative than usual.  Go read some Howard Marks and be patient.