Model RFP can help you ask the right investment questions

You’re an investor, you want help managing your funds, and you’re trying to figure out which investment manager to choose. How do you avoid casting your lot with the next Bernie Madoff?

Matthew Orsagh, CFA, CIPM, senior policy analyst with the Capital Markets Policy Group for the CFA Institute Centre for Financial Market Integrity, says in CFA Magazine that the Model Request for Proposal (Model RFP) developed by the CFA Institute Centre can give investors some questions to ask prospective managers.

Although the Model RFP is intended for use by institutional investors, individuals can use it to develop their own questions to ask potential investment managers. Using the tool to ask the right questions can help investors see red flags that indicate possible problems with an investment manager. Conversely, answers to the questions also can help confirm investors’ faith in their investment managers.

Orsagh contends that many red flags were missed by victims of the Madoff scandal, and if some of the investors had asked the right questions before investing with Madoff, they might have used a more cautious approach. The Model RFP can help investors formulate the right questions.

The Model RFP consists of three parts: Equity, Fixed Income, and Real Estate. All three parts are available free in PDF form from the CFA Institute’s website.

The Model RFP – Equity can be found at http://www.cfapubs.org/toc/ccb/2008/2008/6.

The Model RFP – Fixed Income can be found at http://www.cfapubs.org/toc/ccb/2008/2008/5.

The Model RFP – Real Estate can be found at http://www.cfapubs.org/toc/ccb/2008/2008/4.

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Self-funded reverse mortgages can work in the right circumstances

Reverse mortgages, in which retirees borrow against their homes to create an income stream during retirement, typically are funded through brokers and financial institutions.

However, under the right circumstances, a wealthy family member can take the place of the brokers and institutions and finance a reverse mortgage for close family members. For lack of a better term, call it a privately financed reverse mortgage, or perhaps a do-it-yourself reverse mortgage.

Travis Perry, a Grand Junction attorney, assisted some clients who wished to set up such a private arrangement between an individual and his retired parents.

“This circumstance worked out well because there was a family member who had done well (financially) and had significant cash savings,” Perry says. With that savings, a loan for the parents was created and structured as a reverse mortgage on their home. In a reverse mortgage, the borrowers receive regular payments from a loan on their home, and the lender receives repayment when the home eventually is sold.

Perry says the arrangement in this particular case utilized a deed of trust on the real estate and a promissory note. A loan agreement spelled out details of the deal. The loan carried the going rate of interest on mortgages at the time the deal was closed, and Escrow Specialists of Grand Junction handled the financial arrangements.

“What we avoided were the majority of closing costs,” Perry says. Among the costs of the transaction were attorney’s fees and escrow costs, but most other typical closing costs were avoided, which resulted in a “significant savings,” he says.

“It’s kind of a win-win,” Perry says, pointing out that the borrowers received a low-cost loan at a competitive rate, and the lender received a competitive rate of return on his money.

Perry cautions, however, that such an arrangement for a reverse mortgage is rare and works only when a good relationship exists between the borrower and lender. “The perfect elements to come together haven’t appeared too often,” he says. “But this is a good alternative in the right circumstances.”

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You’ve Got Mail: Pros and Cons of Going ‘Paperless’ with Fidelity

On June 7th, Fidelity will send an e-mail notice to each of our clients who have an e-mail address on file with them. This notice will ask for your consent to enroll in the electronic delivery (eDelivery) of trade confirmations and legal documents, including shareholder material and revised account profiles. The express purpose of these e-mails is to make it easier for you to enroll in eDelivery of documents, and at the end of the message, you will be given a choice to agree with or ignore the e-mail. Agreeing will result in electronic delivery of the said documents, while ignoring it will allow you to continue to receive paper docs. Please note that while we are not necessarily advocating that you switch to electronic delivery of your documents, we do want to explore the issue as an option.

What exactly are the pros and cons of going paperless? In addition to reducing ‘clutter’, there can be some monetary advantages for certain clients – namely, those with less than $1,000,000 in cumulative balances at Fidelity. Fidelity offers a significant discount on trades for clients who go completely paperless – from $17.95 per trade for shares up to 1,000 and a penny and a half for each share over 1000, to $7.95 per trade for shares up to 10,000 and a penny per share over 10,000. On a $500,000 account where Doug is trading a block of 10,000 ETF shares valued at $5.00 each, that would mean a cost of $7.95 for the ‘paperless’ client versus $138.95 for the ‘papered’- a significant savings on an example that Doug describes as ‘very reasonable’. Please note, for this discount to apply, a client would need to be entirely paperless, meaning that they receive their statements electronically too. The message you are receiving on June 7th will strictly be to opt in or out of electronic trade confirms and legal documents - opting for electronic statements can easily be done with a call to our office. Also note that clients with cumulative balances of $1,000,000 or more at Fidelity already receive the discounted fees, so there would be no additional monetary advantage for them.

In the past, the per trade discounts have not really mattered much for clients under $1,000,000, since most tend to be invested in the Fund Scout strategy, which employs the use of mutual funds rather than individual stocks; however, Doug does expect to begin using ETF’s in these portfolios, and these are subject to the same fees as stocks. For that reason, switching to the electronic receipt of documents might make sense going forward.

In order to 'go electronic’, you must be prepared to organize the files on your computer and back-up your files regularly. This can be one significant disadvantage (though you can always print a copy of the documents you receive electronically if you feel you can’t get away from storing the paper copies).

As stated above, we do not necessarily advocate going paperless; in fact, our past recommendation has been against it since we didn’t feel that most of our clients were adequately prepared to organize, store, and back-up their electronic files. This is an issue that is going to continue to come up, however, as businesses continue to strive for more digital and less paper. The paperless movement is not likely to go away, and we are at a point where the cost savings might begin making sense for some clients. If you would like to talk to someone about your specific situation and whether or not it would make sense for you to transition into paperless, please feel free to give us a call at the office – we are always glad to help.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Economy Still Indicated To Grow Through Summer

The stock market’s ups and down, and economic growth – or lack thereof – are not random, but they are difficult to understand at times. May-Investments developed its own Leading Economic Indicator that helps the firm understand the current economic environment. Today’s LEI readings forecast continued economic growth during the months ahead.

May-Investments developed its in-house indicator rather than rely on the more traditional LEI, which is published monthly by The Conference Board. With the Federal Reserve adopting Enron-style off balance sheet financing vehicles in order to move the government’s new bond issuance out the doors into buyers’ hands, the old economic indicators are at risk of becoming obsolete. Investors are having difficulty understanding whether today’s economic growth is a mirage, an encouragement, or a house of cards about ready to fall and take investors down with it.

The resulting economic uncertainty causes many investors to remain on the sidelines for fear of a repeat of the 2008 banking panic. Unfortunately, “the sidelines,” as represented by bank and bond interest rates, pays investors little or nothing, so savers are being hurt by the Federal Reserves’ low interest rate policies, which have been crafted to benefit bankers instead of savers. Long-term investors are being asked to use yesterday’s economic indicators in spite of the apples-to-oranges comparison between the economic environment that preceded the 2008 collapse of Shearson Lehman, and the capital-starved world that we’re in today.

Investors could ignore the big picture, but 2008 proved that approach is too risky. Investors could remain on the sidelines, but inflation is persistently destroying the value of money held in the bank while food, energy, and import prices soar higher. Some investors will decide to use the old indicators, ignoring the sea change in monetary policies that have been adopted since 2008. That approach has worked fairly well since the market bottomed in March of 2009. On the other hand, ignoring the new reality won’t make it go away, and doesn’t mean that it won’t eventually matter (a lot).

May-Investments responded to the new economic realities by replacing outmoded economic indicators with a new Leading Economic Indicator of our own. Built in-house and updated monthly, it shows that the economy began a sharp decline in mid-2008, a few months before Lehman’s bankruptcy and the Wall Street implosion. Through 2009, the economy remained mired and didn’t actually turn up until mid-2010, despite traditional indicators that showed the economy recovering a year earlier. The old indicators put too much emphasis on low interest rates, a traditional indicator of stimulative Fed policy. In fact, low rates were put in place to bail out the distressed banking sector, but bank regulators were busy tightening bank capital requirements and lending rules that left banks shrinking loan portfolios, firing commercial loan customers - even those that were current on their loan payments. The world had changed, but the old indicators weren’t reflecting this new world.

As a result of developing our own indicators, we can say with more confidence that the recovery that began in mid-2010 is still underway, and is not a mirage. Retail sales and drilling activity turned up early and are still positive. Corporate profits have fully recovered. In contrast, small business confidence remains spotty. Even bank lending, which held back the recovery for months, recently turned up. These are healthy signs that give us confidence to invest for the long-term, rather than hiding on the sidelines.

There are certainly concerns, and our indicators help us know where to look for them. Overseas activity has been weakening for several months as higher interest rates abroad slow down the rate of recovery in our export sector. More recently, the technology sector has dropped a bit, presumably (but who knows for certain?) as a result of problems facing the tech sector related to the tsunami crisis in Japan.

When we build client portfolios, we can design them to reduce exposure to some risks (we currently have little foreign stock exposure) while embracing other types of risk, where evidence of the recovery gives us more confidence that risk taking will be rewarded. Most importantly, it has helped us keep our foot off the portfolio brakes when the market began rallying last Fall. We still think that the brakes are important. Our best guess is that we remain in a “trading market” that could go down, a lot, just like it has soared off the 2009 lows.

At times we want to be playing offense, while at other times it makes sense to be more defensive. Our Leading Economic Indicator helps us make sense of this new monetary world in which we find ourselves. As I write this, the view is still encouraging.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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U.S. Market Leading The Way

We’ve noticed a dramatic shift in the markets since the details of the second Quantitative Easing move by the Federal Reserve was announced in early November. Prior to the election and QE2 announcement, the U.S. market was lagging most of our alternative asset classes. Then suddenly, markets reversed course so that now all of the alternatives lag the U.S. broad index.

The first table is as of October 31, 2010.  The sectors and asset classes owned in the mutual fund portfolio model are marked in green, if they are doing better than the benchmark, or red, if they are lagging.

Notice that the majority of alternative asset classes were going up while the U.S. stock market was slightly down during that period. From our selfish standpoint, at that point our model was doing better than the market, and the vast majority of our holdings were doing better than the benchmark.

Then everything changed. The U.S. market started doing better than the alternatives.

Only global commodity stocks were beating the U.S. market, which was in rally mode. We have been struggling, not because we didn’t own better performing alternatives, but because it has been such a narrow market that it is difficult to be very diversified and not have some laggards dragging down portfolio performance.  The second chart is as of March 31, 2011.

In our case, some of our U.S. stock positions, and our gold and precious metals position, were dragging down performance. We recently sold the position in “All that Glitters,” and since quarter-end our utility and pharmaceutical positions have perked up. The insurance holding remains “under water,” though we haven’t owned it for long and since we purchased it, it has generally kept pace with the market.

Thus far, 2011 has been a bit of a Good News/Bad News sort of market. While we are struggling to keep up with our primary benchmark, the S&P 500 Index, the good news is that the broad U.S. stock market is, for now at least, the best game in town.
 
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Biking Grand Junction? Start online

For a growing number of Grand Valley residents, spring means the start of biking season.

If you’re a cyclist – especially an aspiring cyclist – you could just hop on two wheels and try to find your way to the best trails to suit your ability. Take that approach, and you’d get a good workout looking for trailheads and suitable rides.

A better approach would be to start on the computer with two excellent websites that contain detailed maps of mountain bike trails and road bike routes in the area.

The first site, Western Colorado Mountain Biking, is found at http://www.gjmountainbiking.com/. Joel Schaefer and Randy Gehl have assembled the site, which includes photos, trail descriptions, and high-resolution maps of the trails plotted on topographical maps. Schaefer and Gehl have ridden each trail listed on the site and have plotted key locations with distances, elevations, and GPS coordinates.

Gehl points out that you don’t have to be an expert mountain biker to ride in western Colorado. For easier trails, he suggests some of the trails in the Lunch Loops area, whose main trailhead is located just up the No Thoroughfare/Monument Road on the Redlands (on the way to the east entrance of Colorado National Monument). Some easier trails also can be found in the Kokopelli’s Trail area (Rustler’s Loop, http://www.gjmountainbiking.com/koko/rustler.html) and in the 18 Road area near Fruita (specifically, the Vegetarian Loop trail). Gehl says Highline Lake also has a nice three-mile loop.

If road biking is more your style (skinny tires instead of fat tires), the Tomorrow Hill Farm website at http://www.tomorrowhillfarm.com/JohnHodgebicycleMaps.html#Top contains a series of useful maps and trail descriptions focusing mainly on paved routes. The maps and descriptions were compiled by local resident John Hodge, an avid cyclist who writes on the website that “a good map brings confidence and an easier, safer, more fun bicycle ride.”

The maps on these websites are worth a thorough review before you start a ride. You’ll gain an idea of what to expect on the trail, and you can be better prepared for the relative difficulty or each ride. Check them out before you ride.

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Mutual funds and ETFs: What’s the difference?

Since 2007, May-Investments has pursued an investment strategy that is primarily focused on mutual funds. However, as markets become more volatile, the firm expects to reintroduce exchange-traded funds (ETFs) to the portfolio.

Doug May, owner and managing member of May-Investments, says ETFs were once part of the portfolio but were phased out about four years ago. Today, ETFs represent a way for the firm to gain an investment foothold in certain niche industries.

“As we contemplate future market volatility, I would think that ETFs would find their way back into the portfolio,” May says.

So what’s the difference between a mutual fund and an ETF?

Both are legally pooled funds that own investment assets for their shareholders, May says. Mutual funds are designed so that at the end of the trading day, assets in the fund are valued, and the fund trades at net asset value. Basically, you know at the end of the day what the fund’s price is.

In contrast, ETFs are investment pools whose shares trade over the course of the day, rather than at the close of the trading day. As a result, a significant difference can exist between the ETF’s net asset value and the price at which its stock trades. That difference, whether it is a premium or a discount, can create uncertainty that causes investors to shy away from ETF investments.

ETF are designed to track certain indexes, and when they don’t hit their target, investors can become nervous about ETFs.

ETFs exist in specialized industries – for example, utilities – which makes them attractive vehicles for investors looking to move into certain industries.

“We want to control our portfolio, so we’re more interested in the niche ETFs than in broad-market ETFs,” May says.

Many mutual funds are actively managed by professional managers who buy the best stocks of the class in which the fund specializes. In contrast, ETFs tend to buy the biggest stocks in the class without much regard for quality factors. Such a strategy can result in more volatility than typically happens in a mutual fund, May says.

By combining mutual funds and ETFs in a portfolio, investors can gain the advantage of actively managed mutual funds with the potential gains of ETFs that specialize in niche industries, May says. The combination also means that the relative stability of mutual funds can help temper the potential volatility of ETFs.

When ETFs join the portfolio, what will May-Investments clients notice that’s different? Because of the way ETFs operate, clients could see trading costs and commissions in their portfolios for the first time, May says. However, May says the benefits of combining ETFs and mutual funds in the portfolio can be worth the cost.

“I think clients are looking to us to make the right choice between the two,” May says. “Our clients trust us to make the right decision.”

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