The term “private equity” is used to describe various types (e.g., buyout funds and venture capital funds) of privately placed (nonpublicly traded) investments. Even though buyout (BO) funds and venture capital (VC) funds have similar organizational and compensation structures, they are distinguished by the types of investments they make and the way those investments are financed.

BO funds generally acquire 100% of the target firm (which can be public or private) and use leverage. VC funds take minority positions in private businesses and do not use debt financing. Today BO funds account for about three-fourths of private equity deals.

Private equity (PE) excites many investors, offering the opportunity for spectacular returns (although, as with most investments, we generally hear only the stories with happy endings). Even the term conveys an exclusive nature, especially for investors who yearn to be “players.”

Capital committed to PE funds worldwide has risen substantially in the past two decades, thanks largely to U.S. pension funds searching for alternatives to public equity markets that might help them meet their return objectives. Endowments seeking to replicate the successes of the Yale Endowment have also contributed to the growth of PE funds. And it is reasonable to assume that high-risk, illiquid investments are priced by investors to deliver higher expected returns than publicly traded securities to compensate for the greater risk.

The Historical Evidence

Steven Kaplan and Berk Sensoy contributed to the literature on the performance of PE funds through an extensive survey of current research on the performance of private equity. Following is a summary of the findings from their October 2014 paper, “Private Equity Performance: A Survey”:

• BO funds have outperformed the S&P 500 net of fees by about 20%, on average, over the life of the fund.
• VC funds raised in the 1990s outperformed the S&P 500, while those raised in the 2000s have not.
• Before the 2000s, buyout and VC fund performance showed strong evidence of persistence.
• Since 2000, there is little evidence of BO fund persistence (with the exception of persistence among those in the bottom quartile, the worst performers), while VC fund persistence has remained strong.

Unfortunately, the returns data presented by Kaplan and Sensoy isn’t risk-adjusted. Private equity is really much riskier than an investment in a publicly traded S&P 500 Index fund, making it a wholly inappropriate benchmark. For example …

• Companies in the S&P 500 are typically among the largest and strongest companies, while VC typically invests in smaller and early-stage companies with far less financial strength. Studies have estimated betas for BO funds at about 1.3 and for VC funds at 1.6 to 2.5. Adjusting for the higher betas alone would have erased any evidence of outperformance. Similarly risky but also publicly available small value stocks have also outperformed the S&P 500 by a wide margin—from 1927 through 2016, the S&P 500 returned 10.0%, while the Fama-French Small Value Index (ex utilities) returned 13.6%.
• Investors in private equity forgo the benefits of daily liquidity. It’s well-documented in the literature that investors will demand a premium for investing in illiquid assets, especially those that perform poorly in bad times (like PE). There’s no adjustment in the returns data for the risk of illiquidity. In addition to the lack of liquidity relative to investments in mutual funds, private equity investors also forgo the benefits of transparency and broad diversification (and for individuals, the ability to harvest losses for tax purposes).
• The median return of PE is much lower than the mean (the arithmetic average) return. PE’s relatively high average return reflects the small possibility of a truly outstanding return, combined with the much larger probability of a more modest or negative return. In effect, PE investments are like options (or lottery tickets). They tend to provide a small chance of a huge payout but a much larger chance of a below-average return. And it’s difficult, especially for individual investors, to diversify this risk.
• The standard deviation of private equity exceeds 100%, in comparison to standard deviations of about 20% for the S&P 500 and about 35% for small value stocks.

In their survey, Kaplan and Sensoy observed that the authors of the 2013 study, “Limited Partner Performance and the Maturing of the Private Equity Industry,” found that, in the more recent sample of PE funds raised between 1999 and 2006, there was no evidence that endowments outperform other limited partner types or display any superior skill at selecting general partners.

According to Kaplan and Sensoy, this study (which Sensoy also co-authored) concluded that “the disappearing endowment advantage is consistent with other secular trends in the industry, particularly the decline in VC performance since the late 1990s and the decline in performance persistence in BO firms.”

Latest Evidence

Reiner Braun, Tim Jenkinson and Ingo Stoff contribute to the literature on private equity performance and its persistence with their study, “How Persistent is Private Equity Performance? Evidence from Deal-Level Data,” which was published in the February 2017 issue of the Journal of Financial Economics.

Their findings were consistent with those of Kaplan and Sensoy. Their study covered timed cash-flow data at the deal level for 13,523 investments made by 865 buyout funds (not VC funds) run by 269 general partners (GPs). The investments were split roughly equally between the U.S. and Europe, with a few in other regions, and span the period 1974 to 2012. This is important, as most other studies examined only U.S. data.

The authors noted: “As well as being extensive and detailed, for the vast majority of the GPs in our sample we have their complete investment history. This is clearly critical when analysing performance persistence, and lack of completeness is a problem that has plagued earlier analyses. We source the data from three fund-of-fund managers who required all GPs who sought capital to provide this detailed deal-level information in a standardized format. Importantly, the sample includes all the GPs upon which the fund-of-fund managers performed due diligence, whether or not they actually chose to invest.” They also partitioned the data sample into an early period up to the end of 2000 and a later period from 2001 onward.

Following is a summary of their findings …

• While there was evidence of performance persistence in the early period, it was weaker than performance persistence found in previous studies and has largely disappeared in recent years. The authors stated: “This is consistent with the PE sector maturing, with financial engineering and valuation techniques becoming commoditized, professionals moving between or forming new GPs, and the ways to create operational improvements to portfolio companies becoming assimilated across firms.”
• Competition has clearly increased in recent years, but not evenly over time or by region. When a large amount of capital chases deals, persistence tends to be lower.
• There is significant evidence of top-quartile performance persistence but only in low competition states. On the other hand, GPs who make bad deals tend to repeat, irrespective of the state of competition.

Braun, Jenkinson and Stoff concluded: “Overall, the evidence we present suggests that performance persistence has largely disappeared as the PE market has matured and become more competitive.”

They add: “Those Limited Partners (LPs) who were early investors in PE—such as endowments—established relationships with successful GPs which were valuable when the market was developing. However, those relationships, and access to funds—at least on the buyout side—are now much less valuable and are no longer a source of LP out-performance.”

For investors, the research has an important implication: If past performance provides little guidance on the choice of GPs, how can one identify the future top performers

Swensen On Private Equity

If you’re considering investing in PE or sit on the board of a committee that is doing so, be sure to consider these sage words of advice from David Swensen, chief investment officer of the Yale Endowment: “Understanding the difficulty of identifying superior hedge fund, venture capital, and leverage buyout investments leads to the conclusion that hurdles for casual investors stand insurmountably high. Even many well-equipped investors fail to clear the hurdles necessary to achieve consistent success in producing market-beating active management results.”

In his book, “Unconventional Success: A Fundamental Approach to Personal Investment,” Swensen offered the following observation on BO funds: “Investors in buyout partnerships received miserable risk-adjusted returns over the past two decades. Since the only material differences between privately owned buyouts and publicly traded companies lie in the nature of the ownership (private vs. public) and character of capital structure (highly leveraged vs. less highly leveraged), comparing buyout returns to public market returns makes sense as a starting point. But because the riskier, more leveraged buyout positions ought to generate higher returns, sensible investors recoil at the buyout industry’s deficit relative to public market alternatives. On a risk-adjusted basis, market equities win in a landslide.”

Swensen also cited a Yale Investments Office study that provides some insight into the additional return required to compensate for the risk in leveraged buyout transactions. He writes: “Examination of 542 buyout deals initiated and concluded between 1987 and 1998 showed gross returns of 48% per annum, significantly above the 17% return that would have resulted from comparably timed and comparably sized investments in the S&P 500. On the surface, buyouts beat stocks by a wide margin. Adjustment for management fees and general partners’ profit participation bring the estimated buyout result to 36% per year, still comfortably ahead of the marketable security alternative…. Because buyout transactions by their very nature involve higher-than-market levels of leverage, the basic buyout-fund-to marketable-security comparison fails the apples-to-apples standard. To produce a risk-neutral comparison, consider the impact of applying leverage to public market investments. Comparably timed, comparably sized, and comparably leveraged investments in the S&P 500 produced an astonishing 86% annual return. The risk-adjusted marketable security result exceeded the buyout result of 36% per year by an astounding 50%age points per year.”

Summary

The bottom line is that if you’re willing, able and have the need to take more risk in search of higher returns, the most likely to place to find that is not in PE, but rather in publicly available small value stocks. And you can access these higher expected returns through low-cost, passively managed and tax-efficient funds. You can globally diversify their risks as well. In addition, you’ll have all the benefits of daily liquidity and transparency.

This commentary originally appeared March 27 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post Private Equity Adds Risk, Little Return appeared first on West Loop Financial LLC.

Earlier this week, we looked at emerging markets and why many investors stick to domestic stocks due to two biases: home country and recency, despite a compelling case for emerging market investing.

To more fully understand the case for global diversification, I’ll resume the discussion with an exploration of two studies related to emerging markets.

The Importance Of The Book-To-Market Ratio

Michael Keppler and Peter Encinosa, authors of “How Attractive Are Emerging Markets Equities? The Importance of Price/Book-Value Ratios for Future Returns,” which appears in the Spring 2017 issue of the Journal of Investing, provide us with some further insights as to returns we might expect from emerging markets.

For the period January 1989 through October 2016, the authors found that the P/B ratio of the MSCI Emerging Markets Index ranged from a low of 0.90 in January 1989 to a high of 3.02 in October 2007, and averaged 1.75. They then divided the P/B range into three intervals and found:

• For 10 observations, the P/B ratio was below 1.22. The average annual return in U.S. dollars in the four years that followed was 12.9% and never fell below zero.
• For 273 observations in the second interval, the P/B fell between 1.22 and 2.76. The average annual return in the four years that followed was 9.4%.
• In four observations, the P/B ratio exceeded 2.76. The average annual return in the four subsequent years was -5.1%, and was always negative.

Wide Dispersion Of Outcomes

As noted earlier, the current P/B ratio is 1.5, near the bottom of the range for the interval during which the MSCI Emerging Markets Index returned 9.4% over the succeeding four years, and not that far above the interval that produced 12.9% returns over the succeeding four years.

Keppler and Encinosa concluded that there has been a negative relationship between the P/B ratio and future returns in the emerging markets. They also warn investors that focusing on average returns hides a wide dispersion of outcomes.

For example, while their regression analysis led them to forecast a return of 12% per year for emerging markets over the ensuing four years, the data from the prior 28 years indicate the extreme outcomes lie between an annual loss of 8.8% and an annual gain of 36.9%.

Further Findings

Keppler and Encinosa also found the same negative relationship between the P/B ratio and returns in the subsequent four years in the developed markets. Over the period 1970 through October 2016, they found the lowest P/B ratio was l.01 in July 1982, the highest was 4.23 in December 1999 and the average was 2.06. Again, dividing the period into three intervals, they found:

• For 169 observations, the P/B ratio was below 1.70. The average annual return in U.S. dollars in the four years that followed was 15.4% and was never below zero.
• For 319 observations, the P/B ratio was between 1.70 and 3.46. The average annual total return four years later was 7.2%.
• For 27 observations when the P/B ratio was above 3.46, the average annual return over the next four years was -5.6% and was always negative.

Current Expected EM Returns High Than US

The bottom line is that, currently, expected returns among emerging market equities—particularly emerging market value stocks—are much higher than they are for U.S. stocks (as well as those in other developed markets, though to a lesser degree).

Of course, by no means are the higher expected returns a free lunch—they come with greater risks. That said, given that emerging markets now make up more than half of global GDP and about one-eighth of global equity capitalization, the starting point to consider is an emerging markets allocation of one-eighth of your equity allocation.

If you’re an investor who’s willing and able to accept more risk, you might consider a somewhat higher allocation, and vice versa. At any rate, your allocation should not look much different than the global market capitalization; otherwise, you’re betting against the collective wisdom of the market, a very tough competitor. That said, let’s examine the case for global diversification.

Making The Case For Global Diversification

Diversification rightly has been called the only free lunch in investing. A portfolio of global equity markets should be expected to produce a superior risk-adjusted return to any one country or region held in isolation.

However, the benefits of global diversification came under attack as a result of the financial crisis of 2008, when all risky assets suffered sharp price drops as their correlations rose toward one. When that happened, many investors surmised that global diversification doesn’t work because it fails when its benefits are needed most. That is wrong on two fronts.

First, the most critical lesson investors should have learned is that, because correlations of risky assets tend to rise toward one during systemic global crises, their portfolios should be sufficiently allocated to the safest bond investments (investments such as U.S. Treasury bonds, FDIC-insured CDs and municipal bonds rated AAA/AA). The overall portfolio should reflect one’s ability, willingness and need to take risk.

Flights To Liquidity

At the time they’re needed most, during systemic financial crises, the correlations of the safest bonds to stocks—which average about zero over the long term—tend to turn sharply negative. They benefit not only from flights to safety but also from flights to liquidity.

The second lesson many investors failed to understand is that, while international diversification doesn’t necessarily work in the short term, it does work eventually. This point was the focus of a paper by Clifford Asness, Roni Israelov and John Liew, “International Diversification Works (Eventually),” which appeared in the May/June 2011 edition of the Financial Analysts Journal.

The authors explained that those who focus on the fact that globally diversified portfolios don’t protect investors from short systematic crashes miss the greater point that investors whose planning horizon is long term (and it should be, or they shouldn’t be invested in stocks to begin with) should care more about long, drawn-out bear markets, which can be significantly more damaging to their wealth.

Don’t Let Short-Term Failures Blind You

In their study of 22 developed-market countries during the period 1950 through 2008, the authors examined the benefit of diversification over long-term holding periods. They found that, over the long run, markets don’t exhibit the same tendency to suffer or crash together. As a result, investors should not allow short-term failures to blind them to long-term benefits.

To demonstrate this point, the authors decomposed returns into two components: (1) those due to multiple expansions (or contractions), and (2) those due to economic performance.

Most Important Determinant Of Long-Run Returns

The authors found that while short-term stock returns tend to be dominated by the first component, long-term stock returns tend to be dominated by the second. They explained that these results “are consistent with the idea that a sharp decrease in investors’ risk appetite (i.e., a panic) can explain markets crashing at the same time. However, these risk aversion shocks seem to be a short-lived phenomenon. Over the long run, economic performance drives returns.”

They further showed that “countries exhibit significant idiosyncratic variation in long-run economic performance. Thus, country specific (not global) long-run economic performance is the most important determinant of long-run returns.”

For example, in terms of worst-case performances, the authors found that, at a one-month holding period, there was very little difference in performance between home-country portfolios and global portfolios.

However, as the horizon lengthened, the gap widened. The worst cases for the global portfolios are significantly better (the losses are much smaller) than the worst cases for the local portfolios. And the longer the horizon, the wider the gap is favoring the global portfolios.

Demonstrating the point that long-term returns are more about a country’s economic performance and that long-term economic performance is quite variable across countries, the authors found that “country specific economic performance dominates long-term performance, going from explaining about 1% of quarterly returns to 39% of 15-year returns and rising quite linearly in time.”

Summary

We live in a world where there are no accurate crystal balls. Thus, the prudent strategy is to build a globally diversified portfolio. But that’s simply the necessary condition for success. The sufficient condition for success—the second part—is to possess the discipline to stay the course, ignoring not only the clarion cries from those who think their crystal balls are reliable but also the cries from your own stomach to “Get me out!”

As Warren Buffett explained, “The most important quality for an investor is temperament, not intellect.”

To help you stay disciplined and avoid the consequences of the dreaded investment disease known as recency, I offer the following suggestion …

Whenever you are tempted to abandon your well-thought-out investment plan because of poor recent performance, ask yourself this question: “Having originally purchased and owned this asset when valuations were higher and expected returns were lower, does it make sense to now sell the same asset when valuations are currently much lower and expected returns are now much higher?” The answer should be obvious.

And if that’s not sufficient, remember Warren Buffett’s advice to never engage in market timing, but if you cannot resist the temptation, you should buy when others panic and sell.

This commentary originally appeared March 24 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post When Emerging Markets Outperform appeared first on West Loop Financial LLC.

There are no crystal balls to tell us when our time on earth will be up, but some people do experience close calls. These instances are jolting reminders that while our time is limited, our planning and preparation can’t be.

My friend, Paul, is, arguably, in better shape than most people I know. He’s an athlete, he eats right and he takes good care of his body. None of this prevented the cardiac arrest that left him flat lined on a hospital bed, requiring three times before full resuscitation.

His experience makes us think about our own mortality and the suddenness with which decisions — ones we wish we could have made for ourselves — must be made for us. To shed more light on the importance of estate planning, I reached out to estate planning attorney and expert Jennifer Jaynes.

Jennifer outlines two basic scenarios where a little planning makes the difference between an orderly, financially conservative administration of an estate and a long, expensive, chaotic process.

WHAT HAPPENS TO MY ESTATE IF I’M INCAPACITATED?

Without a Plan
If you are in a coma and have never specified who will handle your finances or make health care decisions, someone close to you (spouse, friend or other family member) would need to petition the court to appoint him or herself your conservator. Even if today you know who that person would be, someone must take the time and bear the expense of hiring an attorney to make it official.

Once official, the conservator may face extremely difficult decisions regarding your health. Take Terri Schiavo for example. After cardiac arrest left her in a persistent vegetative state, her husband wanted to take her off artificial life support, but her parents wanted to keep her alive. The two parties were in court for 15 years over the disagreement. Before losing the ability to make that decision for herself, Ms. Schiavo likely never considered the possibility this would happen to her and her family.

With a Plan
By signing the following three documents, you can clarify your wishes while incapacitated:

• A Power of Attorney appoints an “attorney in fact” (not necessarily a lawyer) to manage your finances. It can be effective immediately or upon your incapacity.
• An Advance Health Care Directive appoints someone (commonly referred to as a “health care agent”) to administer your health care decisions and under which conditions you want to be kept alive.
• A Health Insurance Portability and Accountability Act (HIPAA) Release allows the health care agent you designate to access your medical records.

WHAT HAPPENS TO MY ESTATE IF I DIE?

Without a Plan
Again, someone must petition the court to either appoint a decision-maker (an “executor” of the will or an “administrator” of the estate if there is no will). Probate is the process by which the estate is distributed to creditors and beneficiaries. It is generally a lengthy process with significant cost, figured as a percentage of gross estate value (not net after debt). A $2 million estate could face probate costs of $33,000; a $5 million estate could require upwards of $63,000 in probate. Not only will these costs diminish your estate, the decisions made by the probate code/probate court may not align with your wishes.

It is also a public process. Consider the documents your family will have to sort through in to find evidence of who gets what and how much? The stories those documents tell about disagreements, mistakes – in other words, private family business – will be made public.

With a Plan
For around $3,000, a basic estate plan could be sufficient to remove the need for your loved ones to go through probate. It includes the following documents:

• A Revocable Living Trust designates beneficiaries of virtually any of your assets you specify.
  A pour-over will includes guardianship provisions for minor children.
• Transfer documents pre-authorize a smooth transfer of assets to beneficiaries.
• It would also include those documents necessary in the event of your incapacitation (Durable Power of Attorney, Advanced Heath Care Directive and HIPAA Release).

An important reminder: Don’t forget to fund the trust. As a financial advisor, I often see prospective clients make this mistake. Someone may have a wonderfully drafted trust, but they failed to transfer the stock portfolio, real property and/or other assets into the trust. The most artfully drafted trust will not do its job if it’s not funded.

PLAN YOUR LEGACY

Healthy athletes go into cardiac arrest; the unexpected happens. You can’t control your time on earth, but you do have some control over the legacy you leave. Make sure you and, more importantly, your loved ones are well-prepared. You can’t avoid the unexpected, but you might be able to prevent further hardships. Make sure your wishes are clearly stated and your estate plan, as part of a holistic financial plan, is designed to protect those most dear to you.

Learn more about Lifeguard Wealth

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post Estate Planning: An Ounce of Prevention, a Pound of Cure appeared first on West Loop Financial LLC.

Just for fun, Google the words “market pullback.” There are over 2.2 million results–most of them market predictions–and the first page of results is dominated by calls for an imminent market reversal that the simple desk calendar has already proven false.

However, despite their worthlessness, market predictions remain as predictable as market opens and closes. (And I predict no end in sight.)

But why?

First, there’s a clear profit motive. Apparent urgency leads to activity, and activity is still how most of the financial services industry makes its money.

“Bullish predictions encourage investors to pour fresh money into the markets, helping asset management companies to enjoy rising profits,” the New York Times reported, noting that the Wall Street forecaster’s consensus since 2000 has averaged a 9.5% increase each year. They accidentally got it (almost) right in 2016, but in 2008, the consensus prognostication missed the mark by 49 percentage points (an outcome that makes your local weatherman seem like a harbinger of accuracy)!

But not everyone’s positive either. My colleague and the co-author of the new book “Your Complete Guide To Factor-Based Investing,” Larry Swedroe, analyzed Marc Faber’s perpetually cataclysmic proclamations and rendered the good doctor “without a clue.”

But perhaps more surprising, despite the persistent inadequacy of market forecasts, there’s apparently a demand for such soothsaying. Market forecasters capitalize on our unquenchable desire to know the unknowable. “This irrational behavior is caused by an all-too-human need to believe that there is someone who can protect us from bad things happening,” says Swedroe.

Further, “Many individuals believe they are above average in their knowledge, overall judgments, and expertise about all types of money matters,” says Victor Ricciardi, Finance Professor at Goucher College and co-editor of the book Investor Behavior: The Psychology of Financial Planning and Investing.”

The result is that, however un-newsworthy, even venerable publications still print the crap.

What solace can I offer?

On a cosmic continuum, there absolutely is an “imminent” market collapse coming. You can’t predict it, but you can (and should) expect it. And compared even to the relative microcosm of market history, another raging bull market is likely to follow close on its heels.

The rational choice in optimal portfolio structuring, therefore, is to create a portfolio that isn’t designed solely to capitalize on the next market meltdown or spike–but to accommodate both scenarios and everything in between, with balance.

The antidote, therefore, for market hysteria is informed apathy.

Instead of acting on–or even fretting over–a single market prognostication, acknowledge that no one has demonstrated an ability to predict accurately. You’ll be in good company. Warren Buffett, in his recent letter to shareholders, gave this counsel: “[T]he years ahead will occasionally deliver major market declines–even panics–that will affect virtually all stocks. No one can tell you when these traumas will occur.”

And what does he say about those who attempt to predict? “[H]eaven help them if they act on the nonsense they peddle.”

Please recognize this proactive apathy means you likely won’t have sufficient fodder for the watercooler or cocktail party when others are regaling the group with their isolated investment wins and self-loathing losses. But that’s OK, because portfolio volatility isn’t supposed to be the most interesting thing in your life. Your portfolio is better served to simply support the most interesting things in life.

This commentary originally appeared March 18 on Forbes.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post The Antidote To Stock Market Hysteria appeared first on West Loop Financial LLC.

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us.”

These words, from the opening of Charles Dickens’ “A Tale of Two Cities,” are among the most famous in all of English literature. Today they could easily apply to how investors view the outlook for the U.S. economy and our stock market.

Politics Affect Investors’ Market Perceptions

Whether you view the outlook for our economy and stock market as entering the best of times or the worst of times is highly dependent on your political perspective. Research on investor behavior has found that individuals become more optimistic and perceive the markets to be less risky and more undervalued when the party they favor is in power.

This leads them to take on more risk. They also trade less frequently, which is a good thing, because the evidence demonstrates that the more individuals trade, the worse they tend to do. But when the opposite party is in power, investors’ perceived uncertainty levels increase, and they exhibit stronger behavioral biases, leading to poor investment decisions.

You can observe just how strong the impact of these biases can be in the Spectrem Group’s December 2016 Affluent Investor and Millionaire Investor Confidence survey. Prior to the presidential election in November, survey respondents who identified as Democrats showed higher confidence than those who identified as Republicans or Independents. This completely flipped following the election, when Democrats registered a confidence reading of -10 while Republicans and Independents showed confidence readings of +9 and +15, respectively.

The February 2017 University of Michigan survey of consumer confidence provides further evidence. It showed Republican confidence sentiment at 120. This figure hadn’t topped 112 since 1952. For Democrats, the confidence reading was just 55.5, a level not seen since the last recession, when the economy was shedding 2 million jobs a month. Echoing Dickens’ now famous words, Republicans apparently think it’s the best economy in the postwar era, while Democrats seem to think it’s the worst since the financial crisis.

Here’s one more example. Before the 2000 election results were announced, Democrats were slightly more optimistic than Republicans. However, after the announcement of George W. Bush’s win, that changed dramatically. Roughly 62% of Democrats were optimistic about the stock market before the election, but that figure fell to just 36% in early 2001. The optimism about the overall economy was similarly affected.

The Problem Of Political Bias

Political biases create problems for investors, causing them to stray from even well-thought-out financial plans. Imagine the nervous investor who sold equities based on his views of a Trump presidency. While those who stayed disciplined have benefited from the rally, those who panicked and sold not only missed the bull market, they now face the incredibly difficult task of figuring out when it will once again be safe to invest.

It may also be worth noting that Warren Buffett’s Berkshire Hathaway has been persistently buying since the election, despite his having supported Hillary Clinton. Buffett doesn’t let his biases impact his investment decisions, which should be a clue as to whether you should allow your biases to do so.

I know of many investors with Republican/conservative leanings who were underinvested after President Obama was elected. Now it is investors with Democrat/liberal leanings who must face their fears.

It’s important to understand that, if you sell, unfortunately, there’s never a green flag that will tell you when it is safe to get back in. Never. Thus, the strategy most likely to allow you to achieve your goals is to have a plan that anticipates that there will be problems, and to not take more risk than you have the ability, willingness and need to take. Lastly, don’t pay attention to the news if doing so will cause your political beliefs to influence your investment decisions.

Summary

There’s strong evidence that the political climate impacts investors’ views of the economy and the stock market, and that it affects their investment behavior. Specifically, individual investors’ returns improve when the political regime favors their political party, and vice versa.

This result is due to two factors. When their party is in favor, investors tend to increase their exposure to systematic risk and, thus, earn higher returns. They also tend to use more passive strategies, reducing costs.

Unfortunately, investors often make mistakes with their money because they aren’t aware of how decisions can be influenced by their beliefs and biases. The first step to eliminating—or at least minimizing—mistakes is to become cognizant of how our financial decisions are affected by our views, and then how those views can influence outcomes. Being aware of your biases and acting accordingly can help you make better investment decisions.

The bottom line is that, just as you shouldn’t let the latest economic news cause you to abandon a well-developed financial plan and shift your asset allocation, you shouldn’t let the political climate do so either. As the “Oracle of Omaha” Warren Buffett stated in Berkshire Hathaway’s 1996 annual report, “Inactivity strikes us as intelligent behavior.”

This commentary originally appeared March 13 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post Political Biases Can Impact Your Investing appeared first on West Loop Financial LLC.

Despite the evidence showing that past performance is a poor predictor of future mutual fund performance, mutual fund families know that a majority of investors believe this is not the case. Mutual fund families exploit that lack of knowledge, not only by charging high fees for actively managed funds that underperform an appropriate risk-adjusted benchmark, but in an way that most investors are likely unaware of.

During the bull market period 1998 through 2000, 1,337 new mutual funds were created. During that same period, 1,139 IPOs occurred. On the other hand, during the financial crisis from 2008 through 2010, only 138 new funds were opened. And only 153 IPOs occurred. Is the correlation of new fund offerings and IPOs a coincidence? Or is there something else going on?

Evidence Of Exploitation

Frankie Chau, Yi Gu and Christodoulos Louca, authors of the February 2017 study “IPO Allocations and New Mutual Funds,” present evidence demonstrating that mutual fund families are exploiting the lack of sophistication of most investors. Their study covers the period 1998 through 2015.

The authors begin by pointing out that the literature shows both that mutual funds have preferential access to IPOs and that the typical IPO is substantially underpriced. Their study goes on to investigate whether new mutual funds take advantage of such IPO-related opportunities for trade to generate superior performance. Following is a summary of their findings:

• Using the Carhart four-factor model (beta, size, value and momentum) to measure risk-adjusted performance, new funds outperformed more established funds.
• During the six-month period after inception, the average alpha was an annualized 3.94%. The alphas were also consistently positive and statistically significant.
• The magnitude of alphas declined substantially from 8.0% in month one to 1.6% in month two—the outperformance was relatively short-lived.
• The outcome was indifferent to whether the fund was managed by an individual or a team.
• New fund outperformance was concentrated among funds that held IPO stocks, particularly highly underpriced IPO stocks.
• Afterward, performance fell substantially.

The lack of persistence indicates that the results were not skill-driven. Instead, they were a result of the fund family allocating their share (or a large portion) of the IPO to the new fund in order to enhance its performance and attract investor inflows. This effect was found among both large and small fund families, although it was more prevalent among younger fund families.

The Problem Of IPO Flipping

These findings are consistent with those of Jon Christopherson, Zhuanxin Ding and Paul Greenwood, authors of the study “The Perils of Success,” which was published in the Winter 2002 issue of The Journal of Portfolio Management.

They found that “IPO flipping” is most prevalent in the small-cap funds of large fund families. Specifically, large fund families tend to assign a very large portion of their total IPO allocation to one small fund, where it can have a large impact on returns.

Fund families know that if they allocate their share of an IPO to a fund with tens of billions of dollars in assets, the impact on the fund’s return is diluted relative to the impact it would have on a new fund with very little assets. This leads to the allocation of large shares of the IPO to where the impact is greatest (to the detriment of the fund family’s other funds and their investors).

Christopherson, Ding and Greenwood also found another bias in the data—front-running. A large fund family with a small-cap fund has the small-cap fund buy shares of stocks with a low market cap and limited liquidity. Other funds in the same family then pile in, buying more shares. The limited supply of stock allows the large fund family to drive up prices with relatively small purchases by each fund. The returns of the new fund then look great.

The findings are also consistent with those of Jose-Miguel Gaspar, Massimo Massa and Pedro Matos, authors of the study “Favoritism in Mutual Fund Families? Evidence on Strategic Cross-Fund Subsidization,” which was published in the February 2006 issue of The Journal of Finance. They found strong evidence that mutual fund family organizations often play favorites with their funds, strategically transferring performance across member funds, to increase overall fund family profits. Such favoritism can take the form of the selective allocation of underpriced IPOs.

Summary

Chau, Gu and Louca concluded: “IPO allocation is an effective strategy that enhances investment flows during the early months after the inception of a new fund.”

In other words, it’s a logical and profitable strategy for the fund family. For investors, it’s important to understand that, though outperformance related to IPOs is short-lived and the effect dissipates over time, it still lingers in performance data for years to come, luring in unsuspecting investors who believe that past performance is predictive of future performance.

This commentary originally appeared March 10 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post IPOs Used To Pull In Investors appeared first on West Loop Financial LLC.

Institutional investors are generally considered “smart money” that exploits the behavioral biases of “dumb” retail money. However, there have been some holes poked in that idea recently.

For instance, Roger Edelen, Ozgur Ince and Gregory Kadlec, authors of the study “Institutional Investors and Stock Return Anomalies,” which was published in the March 2016 issue of the Journal of Financial Economics, write that while prior research had found a positive relationship between smart money and return anomalies at shorter time horizons (three to 12 months), it turns negative for longer horizons.

Study Findings

They found: “Not only do institutional investors fail to tilt their portfolios to take advantage of anomalies, they trade contrary to anomaly prescriptions. Most notably, they have a strong propensity to buy stocks classified as ‘overvalued’ (i.e., the short leg of anomaly portfolios). For example, during the anomaly portfolio formation window (prior to anomaly returns) there is a net increase in both the number of institutional investors and fraction of shares held by institutional investors in short-leg stocks for all seven of the anomalies we consider. In four of the seven anomalies there is significantly greater institutional buying in short-leg stocks than in long-leg stocks. There is significantly greater buying in long-leg stocks in only one case.”

This surprising finding was in sharp contrast to prior research on performance, with the difference being the horizon period studied. They confirmed this horizon effect, finding a significant positive relation between quarterly changes in institutional holdings and next-quarter returns that turns significantly negative as the time horizon extends to a year or longer. Thus, the authors concluded that “while institutional trades seem to be informed when evaluated over short horizons, that assessment seems premature when evaluated over a longer horizon.”

These findings suggest that institutional investors actually fail to exploit well-known anomalies. Instead, they contribute to their persistence. Thus, the short-term outperformance may not be the result of a “smart money” effect, but instead a result of the price pressure associated with persistent institutional trading, as opposed to informed trading.

This hypothesis is consistent with the findings of George Jiang and H. Zafer Yuksel, authors of the study “What Drives the ‘Smart-Money’ Effect? Evidence from Investors’ Money Flow to Mutual Fund Classes,” which was published in the January 2017 issue of the Journal of Empirical Finance.

By studying mutual fund flows for retail (unsophisticated) and institutional (sophisticated) investors, they found that short-term persistence in performance is not due to the so-called smart money effect, but was instead caused by persistent flow. And the persistence of short-term performance then experiences a long-term reversal. In other words, institutional investors (at least institutional mutual funds) are also noise traders who can contribute to mispricings.

Who Exploits Anomalies?

Because someone owns the long leg of the anomalies, it begs the question: Who is exploiting these well-known anomalies? Mustafa Onur Caglayan and Umut Celiker provide the likely answer through their January 2017 study, “Hedge Fund vs. Non-Hedge Fund Institutional Ownership and the Book-to-Market Effect,” which covers the period July 1982 to June 2014.

The book-to-market (or value) effect is a good choice to study, as it’s well-known, and there are both risk-based and behavioral-based explanations for it in the literature. While naive investors’ overreaction could contribute to the book-to-market effect even if it’s partly explained by a risk premium, sophisticated investors—namely, institutions—should exploit this return predictability, take advantage of the anomaly and therefore mitigate the extent of overreaction. However, we saw previously that, at least in the case of mutual funds, institutions are contributing to any price overreaction, not correcting it.

Caglayan and Celiker tested whether there is a difference between hedge funds and nonhedge-fund institutional investors in terms of their ability to adjust their positions in order to take advantage of the book-to-market effect, and whether hedge funds’ decisions to invest or disinvest in a particular stock predicts future stock returns in the context of the book-to-market anomaly.

The authors focused on hedge funds and non-hedge funds’ change in stock ownership in the most recent quarter prior to the return measurement window of anomaly returns. They found evidence of a statistically significant and drastic change in hedge funds’ behavior as they adjust their preferences from growth to value stocks immediately after the book-to-market values of equities become public knowledge.

Hedge Funds Act On Information

In addition, they show that hedge funds detect overpriced growth securities and trade them to their advantage, especially when non-hedge funds move aggressively in the opposite direction. This is consistent with the idea that hedge funds are the informed investors. On the other hand, they found that non-hedge fund institutional investors do not alter their positions significantly when the information becomes public knowledge.

Specifically, the authors write: “Overvalued (growth) stocks heavily bought by non-hedge funds and simultaneously sold by hedge funds in the most recent quarter underperform significantly in the next year, generating an eye-opening three-factor alpha of -1.33% per month with a t-statistic of -5.54 and a four-factor alpha of -1.23% per month with a t-statistic of -5.21…. On the other hand, we do not find any significant negative subsequent abnormal returns for stocks sold by non-hedge funds and heavily bought by hedge funds.”

They concluded that their findings “support the notion that hedge funds detect negative information on stocks and trade them to their advantage by unloading them especially when non-hedge funds move aggressively in the opposite direction.”

They added: “It is also noteworthy to indicate that the underperformance of growth stocks heavily bought by non-hedge funds and contemporaneously sold by hedge funds lasts in all four quarters analyzed. In other words, the underperformance of these stocks in the subsequent year is not due to an underperformance in one or two quarters, but is due to underperformance in each of the four quarters, showing that our results exist in each quarter during the return measurement window of anomaly returns, and hence the impact of price pressure is completely ruled out.”

Finally, they also noted that their results held not only for the full period, but for both subperiods they studied as well.

It’s important to observe that the evidence showed a stronger ability for hedge funds to detect overpriced securities compared with underpriced securities. This aligns with the theory of limits to arbitrage and short-sale constraints, which allow mispricings to persist even after publication.

The Limits Of Arbitrage

As the authors note: “It is well known that the arbitrage of underpriced securities requires only the purchase of such stocks, while the arbitrage of overpriced securities requires the short-sale, which is much more costly for investors. Therefore, the disappearance of underpriced stocks takes much less time compared to the disappearance of overpriced securities.”

The issue of how limits to arbitrage allow anomalies to persist is discussed in detail in “Your Complete Guide to Factor-Based Investing,” my latest book, which I co-authored with Andrew Berkin.

While the evidence shows that hedge fund managers are skilled, unfortunately the historical evidence also demonstrates that they keep any “economic rent” (as you should expect, because the ability to generate alpha is the scarce resource) that results from their skill. An indication of this can be found in the fact that investors in hedge funds have not been well rewarded.

For example, for the 10-year period ending in 2016, the HFRX Global Hedge Fund Index lost 0.6%, underperforming every major equity and bond asset class. The underperformance ranged from 0.4 percentage points when compared to the MSCI EAFE Value Index to as much as 8.8 percentage points when compared to U.S small-cap stocks.

Thus, if you want to capture the premiums provided by anomalies (such as the book-to-market effect), you should invest in low-cost, passively managed funds that seek to capture the returns available in a systematic way.

This commentary originally appeared February 10 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post Turns Out the “Smart Money” Isn’t appeared first on West Loop Financial LLC.

Institutional investors are generally considered “smart money” that exploits the behavioral biases of “dumb” retail money. However, there have been some holes poked in that idea recently.

For instance, Roger Edelen, Ozgur Ince and Gregory Kadlec, authors of the study “Institutional Investors and Stock Return Anomalies,” which was published in the March 2016 issue of the Journal of Financial Economics, write that while prior research had found a positive relationship between smart money and return anomalies at shorter time horizons (three to 12 months), it turns negative for longer horizons.

Study Findings

They found: “Not only do institutional investors fail to tilt their portfolios to take advantage of anomalies, they trade contrary to anomaly prescriptions. Most notably, they have a strong propensity to buy stocks classified as ‘overvalued’ (i.e., the short leg of anomaly portfolios). For example, during the anomaly portfolio formation window (prior to anomaly returns) there is a net increase in both the number of institutional investors and fraction of shares held by institutional investors in short-leg stocks for all seven of the anomalies we consider. In four of the seven anomalies there is significantly greater institutional buying in short-leg stocks than in long-leg stocks. There is significantly greater buying in long-leg stocks in only one case.”

This surprising finding was in sharp contrast to prior research on performance, with the difference being the horizon period studied. They confirmed this horizon effect, finding a significant positive relation between quarterly changes in institutional holdings and next-quarter returns that turns significantly negative as the time horizon extends to a year or longer. Thus, the authors concluded that “while institutional trades seem to be informed when evaluated over short horizons, that assessment seems premature when evaluated over a longer horizon.”

These findings suggest that institutional investors actually fail to exploit well-known anomalies. Instead, they contribute to their persistence. Thus, the short-term outperformance may not be the result of a “smart money” effect, but instead a result of the price pressure associated with persistent institutional trading, as opposed to informed trading.

This hypothesis is consistent with the findings of George Jiang and H. Zafer Yuksel, authors of the study “What Drives the ‘Smart-Money’ Effect? Evidence from Investors’ Money Flow to Mutual Fund Classes,” which was published in the January 2017 issue of the Journal of Empirical Finance.

By studying mutual fund flows for retail (unsophisticated) and institutional (sophisticated) investors, they found that short-term persistence in performance is not due to the so-called smart money effect, but was instead caused by persistent flow. And the persistence of short-term performance then experiences a long-term reversal. In other words, institutional investors (at least institutional mutual funds) are also noise traders who can contribute to mispricings.

Who Exploits Anomalies?

Because someone owns the long leg of the anomalies, it begs the question: Who is exploiting these well-known anomalies? Mustafa Onur Caglayan and Umut Celiker provide the likely answer through their January 2017 study, “Hedge Fund vs. Non-Hedge Fund Institutional Ownership and the Book-to-Market Effect,” which covers the period July 1982 to June 2014.

The book-to-market (or value) effect is a good choice to study, as it’s well-known, and there are both risk-based and behavioral-based explanations for it in the literature. While naive investors’ overreaction could contribute to the book-to-market effect even if it’s partly explained by a risk premium, sophisticated investors—namely, institutions—should exploit this return predictability, take advantage of the anomaly and therefore mitigate the extent of overreaction. However, we saw previously that, at least in the case of mutual funds, institutions are contributing to any price overreaction, not correcting it.

Caglayan and Celiker tested whether there is a difference between hedge funds and nonhedge-fund institutional investors in terms of their ability to adjust their positions in order to take advantage of the book-to-market effect, and whether hedge funds’ decisions to invest or disinvest in a particular stock predicts future stock returns in the context of the book-to-market anomaly.

The authors focused on hedge funds and non-hedge funds’ change in stock ownership in the most recent quarter prior to the return measurement window of anomaly returns. They found evidence of a statistically significant and drastic change in hedge funds’ behavior as they adjust their preferences from growth to value stocks immediately after the book-to-market values of equities become public knowledge.

Hedge Funds Act On Information

In addition, they show that hedge funds detect overpriced growth securities and trade them to their advantage, especially when non-hedge funds move aggressively in the opposite direction. This is consistent with the idea that hedge funds are the informed investors. On the other hand, they found that non-hedge fund institutional investors do not alter their positions significantly when the information becomes public knowledge.

Specifically, the authors write: “Overvalued (growth) stocks heavily bought by non-hedge funds and simultaneously sold by hedge funds in the most recent quarter underperform significantly in the next year, generating an eye-opening three-factor alpha of -1.33% per month with a t-statistic of -5.54 and a four-factor alpha of -1.23% per month with a t-statistic of -5.21…. On the other hand, we do not find any significant negative subsequent abnormal returns for stocks sold by non-hedge funds and heavily bought by hedge funds.”

They concluded that their findings “support the notion that hedge funds detect negative information on stocks and trade them to their advantage by unloading them especially when non-hedge funds move aggressively in the opposite direction.”

They added: “It is also noteworthy to indicate that the underperformance of growth stocks heavily bought by non-hedge funds and contemporaneously sold by hedge funds lasts in all four quarters analyzed. In other words, the underperformance of these stocks in the subsequent year is not due to an underperformance in one or two quarters, but is due to underperformance in each of the four quarters, showing that our results exist in each quarter during the return measurement window of anomaly returns, and hence the impact of price pressure is completely ruled out.”

Finally, they also noted that their results held not only for the full period, but for both subperiods they studied as well.

It’s important to observe that the evidence showed a stronger ability for hedge funds to detect overpriced securities compared with underpriced securities. This aligns with the theory of limits to arbitrage and short-sale constraints, which allow mispricings to persist even after publication.

The Limits Of Arbitrage

As the authors note: “It is well known that the arbitrage of underpriced securities requires only the purchase of such stocks, while the arbitrage of overpriced securities requires the short-sale, which is much more costly for investors. Therefore, the disappearance of underpriced stocks takes much less time compared to the disappearance of overpriced securities.”

The issue of how limits to arbitrage allow anomalies to persist is discussed in detail in “Your Complete Guide to Factor-Based Investing,” my latest book, which I co-authored with Andrew Berkin.

While the evidence shows that hedge fund managers are skilled, unfortunately the historical evidence also demonstrates that they keep any “economic rent” (as you should expect, because the ability to generate alpha is the scarce resource) that results from their skill. An indication of this can be found in the fact that investors in hedge funds have not been well rewarded.

For example, for the 10-year period ending in 2016, the HFRX Global Hedge Fund Index lost 0.6%, underperforming every major equity and bond asset class. The underperformance ranged from 0.4 percentage points when compared to the MSCI EAFE Value Index to as much as 8.8 percentage points when compared to U.S small-cap stocks.

Thus, if you want to capture the premiums provided by anomalies (such as the book-to-market effect), you should invest in low-cost, passively managed funds that seek to capture the returns available in a systematic way.

This commentary originally appeared February 10 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post Turns Out the “Smart Money” Isn’t appeared first on West Loop Financial LLC.

Every year, I like to keep track of the predictions “gurus” and other market observers make for the upcoming year, specifically the ones they say are “sure things.” It seems like no one in the financial media holds them accountable (which is a shame, since the evidence shows there are no good forecasters), so I will. Today, we will look at some common predictions I’ve been hearing from gurus and investors for 2017.

First Sure Thing

The Federal Reserve will continue to raise interest rates in 2017. That leads many to recommend that investors limit their bond holdings to the shortest maturities. Economist Jeremy Siegel even warned that bonds are “dangerous.”

Second Sure Thing

With the large amount of fiscal and monetary stimulus we have experienced, and with the anticipation of a large infrastructure spending program, the inflation rate will rise significantly.

Third Sure Thing

With the aforementioned stimulus, anticipated tax cuts and a reduction in regulatory burdens, the growth rate of real GNP will accelerate, hitting 2.2% this year.

Fourth Sure Thing

This one follows from the first two. With the Fed tightening monetary policy and our economy improving—and with the economies of European and other developed nations still struggling to generate growth, and with their central banks still pursuing very easy monetary policies—the dollar will strengthen. The dollar index ended 2016 at 102.38.

Fifth Sure Thing

With concern mounting over the potential for trade wars, emerging markets should be avoided.

Sixth Sure Thing

With the Shiller cyclically adjusted price-to-earnings (CAPE) ratio at 27.7 as we entered the year (66% above its long-term average), domestic stocks are overvalued. Compounding the issue with valuations is that rising interest rates make bonds more competitive with stocks. Thus, U.S. stocks are likely to have mediocre returns in 2017. A group of 15 Wall Street strategists expect the S&P 500, on average, to close the year at 2,356. That’s good for a total return of about 7%.

Seventh Sure Thing

Given their relative valuations, U.S. small-cap stocks will underperform U.S. large-cap stocks this year. Morningstar data showed that, at the end of 2016, the prospective price-to-earnings (P/E) ratio of the Vanguard Small Cap Index Fund (VB) stood at 21.4, while the P/E ratio of its Vanguard 500 Index Fund (VOO) stood at 19.4.

Eighth Sure Thing

With the non-U.S. developed and emerging market economies generally growing at a slower pace than the U.S. economy (and with many emerging markets hurt by weak commodity prices, slower growth in China’s economy, the Fed tightening monetary policy and a rising dollar), international developed-market stocks will underperform U.S. stocks this year.

That’s my list. Keep in mind that, if these truly are sure things, most (if not all) should happen. We’ll report back to you with a score at the end of each quarter.

This commentary originally appeared February 1 on ETF.com

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

The post ‘Sure Things’ to Watch for in 2017 appeared first on West Loop Financial LLC.

The word fiduciary has been in the news a lot of late, from Wall Street to Washington, but it’s a word that has always been part of our daily dialogue. Advisors who act as fiduciaries, as we do, are legally required to put the interest of their clients before everything else. As Tim Maurer says in this BAM ALLIANCE foundational film, “Fiduciary — to me, to us — is really about a state of heart, a state of mind. It’s the way we operate. It’s who we are. It’s the only way we know how to do things.”

By clicking on
any of the links above, you acknowledge that they are solely for your
convenience, and do not necessarily imply any affiliations, sponsorships,
endorsements or representations whatsoever by us regarding third-party Web
sites. We are not responsible for the content, availability or privacy policies
of these sites, and shall not be responsible or liable for any information,
opinions, advice, products or services available on or through them.

© 2017, The BAM ALLIANCE

The post “A State of Heart” Featuring Tim Maurer appeared first on West Loop Financial LLC.