I'm Back

It has been a long few days, but I'm back now. I'll spend a bit of time getting caught up on things before I post the next piece on diversification. I hope to go a bit deeper with this one, and really get into some solid ideas. Keep watching!

Until next time...

Going Incognito

From tomorrow, Friday 22 June, until Sunday, 24 June, I will be attending a personal development seminar all day. Thus, I will be unable to make any posts of any great length, although I may be able to pop in with random thoughts every now and again. Just to let you, my readers, know that I am not being derelict in my duty. This is something I've had planned for months and now the time has come. I will be back to "normal" on Monday.

Until the next post, remember, as James Russell Lowell said, "Not failure, but low aim, is a crime."

Cheers!

Diversification Part III

Now, one thing that somewhat concerns me about my stated asset allocation is that it is long only. Now, I'm not paid to hedge for a living, like Veryan Allen is, so I'm not really sure how to address this deficiency. Could I add some index puts, or even puts on specific shares? I have really tried to avoid going to the company level just because I don't have the time to do the analysis that I'd like. Reader feedback would be most appreciated. I've looked at some of the ETFs and funds which have a shorting component to their mandate, but not in depth. Besides, shorting seems to require a completely different mindset from long only investing, and I do have concerns about the typical fund managers' ability to implement both successfully.

In the future, I think there is room to slice the portfolio up even more. I like the approach (at least conceptually) of having a core portfolio made up of index funds or ETFs, then overlaying the core with specific stocks, funds, options positions, or other tools to add alpha. "Core and explore", portable alpha, whatever you want to call it.

On the other hand, maybe my asset allocation is too segmented and should be scaled back.

Maybe my current asset allocation can serve as the "core" in a "core and explore" approach. I don't want to layer on too much complexity, although I think I can keep up with it right now. However, I keep finding interesting ideas to potentially add to the portfolio.

Anyway, I'd love to hear any good ideas from my readers on any of the above points. I'll have to move covered call writing to my next post. Until then...

Diversification Part II

Continuing with the theme of diversification...

In my last post on the topic, I wrote about my current asset allocation and ways I might tweak it. In this post, we'll look at the specific tweaks I'm considering.

The first and most obvious way would be to adjust the allocations, which is what I'm looking at doing now. I'm very heavily weighted toward US small cap equities at the moment, and that is intentional. However, I think I can probably increase my allocation to US large caps to 10% (split between 2 funds) of the total and scale back the exposure to international mid cap equities a bit. I'm thinking of reducing my total international mid cap exposure to 15% total, or 7.5% per fund (currently). I effectively have no commodity exposure now, so that needs to change to the tune of about 5%. The real estate exposure could probably be bumped up more (currently 4%), but I need to increase the foreign real estate exposure and decrease reliance on the US. I think 2.5% US/2.5% foreign real estate makes sense for now. The US fixed income allocation will drop to 7.5% from 8% and the international/emerging market fixed income will drop to 5% from 6.25%.

I've already described my current allocations, so by making the above changes I get this:

20% US small cap equities
15% International mid cap equities
10% US large cap equities
10% International small cap equities
7.5% US Fixed Income (FI)
6% International large cap equities
6% Emerging market (mkt) equities
5% International & emerging mkt FI
5% US TIPS
5% Commodities
2.5% US real estate
2.5% Foreign real estate
2% Cash

As it stands, I have 3.5% to re-allocate. Considering that my outlook is lots of inflation and better foreign and emerging market performance than US market performance in the longer term, I think I'll weight most of that toward increased emerging market equity and commodities. With rising rates (to combat inflation), as well as just having some "dry powder", I'll increase the cash allocation as well, but only by a small amount.

I plan to get the commodity exposure outside of funds, either using ETFs or direct investment in the metals. No more futures or options on futures for me, at least not anytime soon!

So, the final changes to the above asset allocation become:

7% Emerging market equities
6.5% Commodities
2% Cash (brokerage account)

Now, some of this will be easier because Merrill Lynch, home of my oldest 401(k), informed me that they have an agreement with my employer to roll those accounts into the new 401(k) plan at Fidelity. (Joy!) I didn't particularly like the offerings at Fidelity, but thanks to 401khelp.com I was able to structure something that worked for me. At least now I'll have all of the funds in one account, which will make re-balancing and general administration easier.

Secondly, I plan to sell the oldest 100 shares of SPXJX in my portfolio. SPXJX is a Japanese value fund and makes up almost half of the international mid cap equity allocation. I don't see that allocation changing dramatically anyway, but I'd still prefer to have a little more cash on hand. SPXJX has had a nice little run, and I'll get dinged for long term capital gains on it. Not a problem. I want to avoid a loss; it really is about capital preservation.

The next way I've been considering juicing my returns is to engage in some covered call writing, as James Stewart of SmartMoney.com and the WSJ has spoken of doing. (Argh! This is what I get for being lazy on completing that damn options application!) While this isn't strictly a diversification strategy, it serves the same purpose - reducing risk while capturing return. I think I'll write more about my ideas in this regard next time....

Inside look at the Audi R8 production line

Too cool! Thanks to Foursprung for the link to the German Car Blog which redirected from Fourtitude.

Test Drive I: Audi A8L

I completely forgot to mention the test drive I took last week. So let me fill in the blanks.

Thursday, 7 June, I took some time to meander down to the Audi dealership about 1 mile from my apartment. My reason - to test drive an Audi A8L. Some of you may remember that I rented this same vehicle during one of my last trips to SoCal. I figured this was a good place to start for my test drive project.

So after locating a sales guy, I sat down and ran through the plan. I was coming back the following day, Friday, between 1 and 2 pm EDT to test drive the A8L. He said he'd come in even though it was his off day and make it happen. Sweet!

So the next day, I arrived. I was a bit late - closer to 1:45 pm, but hey, it was still inside the window. I located the sales guy and he had me wait at his desk while he pulled the car around. After giving a little demo of some of the features, I was off. I specifically requested a chance to drive the car alone as opposed to taking the sales guy with me. Having driven the A8L before (and paying for the pleasure), I didn't really see the point.

Now, let me say that, with the exception of the MMI (MultiMedia Interface), nothing about the car let me down. It was superb. Again. Shifting the suspension to dynamic was great for those twisty back roads, where I could open up and really connect with the road. On comfort, it was smooth as silk. I'd have never known I was doing 90 on 95 South unless I looked at the speedometer (which I did eventually). From about 50 - 90 was a blur; not instantaneous, but very snappy. I didn't try out the sport mode (clutchless manual aka paddle shifter) but there will be time for that in the future. Besides, I was looking at this vehicle from a comfort and relaxation perspective. When I get into sporty mode, I'm sure Mercedes and BMW will have appropriate vehicles for me. The A5 and S8 don't debut for many months, unfortunately, so I'll have to come back anyway.

So, that was the story of my first test drive. Next up: BMW 750iL.

Until next time...

Breather

Yeah, I had to take one. It has been a hectic week/month/year. In the last week, I've begun working on selling off several domain names I possess, working a few real estate purchases outside of the DC area, and getting another one (in Baltimore) back on track after it approached the brink of failure. More about that last deal later, as in, after we close it. For now, let me just say that the second part of the diversification series is forthcoming. I'm just firming up and fleshing it out now. Stay tuned.

Until the next post...

Overshoot

I've thought for a while that the Fed would, characteristically, overshoot on the way up (raising rates). It does look like that will happen, although possibly not for reasons that one might expect.

Consider that central banks around the globe are raising interest rates and generally slowing the growth of liquidity. (I don't know if you could say they are stopping or reversing it, but attempting [halfheartedly?] to slow it.) So now, based on the (flawed?) economic feedback that the Fed seems to be getting for the second quarter, it looks like they may be forced to raise the Fed Funds rate by at least 25 basis points. (Most likely 25, since when was the last time this Fed was aggressive?)

Its clear that there is weakness in the economy already. (I wish there was more in residential RE in the Washington, DC area, but that's a topic for another time.) So however the Fed is monitoring the state of the economy would appear to be broken. However, using their flawed data, and comparing this with the relatively low rates on the books in this country, as well as the effects of rate raising by other CBs, and I can see a scenario where the Fed is forced to overshoot. Should this happen, it will only induce more pain on consumers, leading to slower economic growth and a more potent slowdown than many commentators seem to be expecting already. Its not like the Fed will raise rates to stop the dollar's decline (at least, not purposefully). They don't care if the dollar is competitive against other currencies; this administration seems to be quite strongly in favor of a weaker dollar. BUT the politics factor will come into play, and voters don't like politicians who preside over high inflation. (At least, they shouldn't BUT...) In that case, you could be looking at bad bond returns through the end of the year (especially Treasuries) without a chance for easing until early 2008. Did I miss anything?

Stephanie Pomboy said it a while ago in the pages of Barron's, and I'm going to agree now -- if you don't see at least the case for stagflation, you're crazy!

Now, will it be a full on 70s style stagflation? I don't friggin' know! I doubt it, actually, but I do think stagflation is the right word. (Personal opinion.) But I think the answers are pretty clear in terms of what to invest in going forward.

PE in South Africa

Now this is really interesting, and pretty cool from the empowerment angle. I never would have considered that private equity might take on a profile of being a backdoor method of Black economic development, and in South Africa of all places! Maybe things aren't as well developed in the US as they seem. Or maybe they are further along elsewhere than they seem. Hmmm.

This story also makes me wonder if a firm like The RLJ Companies would ever consider this type of project. I know that Robert Johnson (yes, of BET fame or infamy, however you choose to describe his notoriety) has setup a mid-sized PE shop in conjunction with The Carlyle Group. However, Bob Johnson is also very proud of his "value creator" stripes, and this type of deal may be too altruistic for him. But one can dream, can't he?

Financial Astrology

Just found this article on FT.com (by way of The Big Picture) about financial astrology. I have been meaning to look at this more closely since I started studying astrology a few years ago. Maybe now is the time.

Alpha *is* Real

Some weeks ago I was reading a post over at My Money Blog and I saw the words efficient and market in the same sentence. Reading those two words in such close proximity always sends alarms off in my head.

Now, I might be totally out of it on this one, but it seems clear to me that "alpha" does really exist and can be captured by capable market operators. The simple reasons are [1] even though all information may be in the market (which is a generally false assumption to begin with), the market may not be pricing that information correctly and [2] there may be non-public information which some operators are using to their advantage in public markets.

A classic example of the first case would be Enron. How many analysts, whose job it is to read financial statements and create analyses of companies, missed holes in the Enron cash flow statements that pointed to the company's demise? They all had access to the same information. So what happened? Obviously the information did not carry the same weight with these analysts that it did with the hedge funds that were short Enron.

Same information, different eyes, different interpretations.

As for the second problem, witness the options or share activity on acquisition targets prior to the announcement of the purchase (a frequent occurrence recently). If it were true that price moves were due to public information exclusively, then how is it possible to have insider trading? If everyone is an insider, then there can't be any insiders. Right? Someone has to know something that someone else doesn't AND they have to use that information against other operators in the public market. In this case, the information is not anything that could be gleaned from research, inquiry, observation and investigation. It is material, non-public information that is supposed to be shared with the public at large when it is made public.

A friend of mine used to have the following quote in his e-mail signature back in college:

"Information - the currency of the future."

It was a very prescient statement. I love the title of Roger Ehrenberg's blog because that is exactly the explanation of how alpha is generated - information arbitrage. More data, of greater quality, with better analysis applied to it, and generating actionable information which is then used to originate trades in which the operator has the utmost faith in the information (and the process which led to it). As Joel Spolsky said, you have to use tools which you can trust or tools which you can fix.

Now, there's nothing you can do about use of material, non-public information by insiders (whether used against you or in your favor). I just hope you are positioned to execute your trading plan if the price goes in your favored direction. If it goes against you, then hopefully your trading discipline will stop the situation from spiraling out of control. You can, however, have better information based on publicly available data and observable facts, and act on it.

So then it really comes down to the information and the process. If you can find the leak in either of those (usually someone else's but also in your own), you can find the alpha. Just make sure to move on it before it moves away from you!

Until next time...