Posts Tagged ‘Wall Street Journal’

Leveraged ETF’s in the News – Wall Street Journal

July 23, 2009

I continue to be concerned about the use of leveraged ETF’s by retail clients. These complicated products offer the exact opposite return of an index multiplied by a factor of either 2 or 3, but this performance is only for one day. Basically, if the S&P drops 5%, an inverse ETF goes up 5%, a 2X Leveraged ETF goes up 10%, and a 3X Leveraged ETF goes up 15%. However, when these products are held beyond one day, their performance can be wildly different than what most investors would expect.

The leverage creates a characteristic that is called volatility drag. It is very similar to compounding and causes the longer term performance to be much higher or lower than the underlying index. These products have a place, but only the most knowledgeable active managers should use them. I’m not convinced that they reduce risk and believe, that for most investors, they dramatically increase portfolio risk!

Evidently, one major brokerage firm agrees. Here’s the article from the Wall Street Journal.

The End of Common Sense

July 13, 2009

Almost every financial publication, tv and radio show, has now declared the process of asset allocation dead. Amazing what happens when academics, investment guru’s, and investment sales people try to explain why they didn’t see 2008 in advance. And today, no less than the Wall Street Journal, has added to the mix with the following article entitled, “Failure of a Fail Safe Strategy Sends Investors Scrambling“, which I dugg (a net term meaning “uploaded to Digg”). Anyway, I do think that the Journal does produce some of the best titles and news reporting in journalism and the article is very well written. The reporter is not editorializing and doesn’t really indicate his opinion of the facts gathered. What is striking is the wide acceptance of the “death” of asset allocation.

Now is evidently the time for stock traders, short sellers, sector rotation, market timers, pick a strategy, because this time their previously debunked strategies will work. Now, understand I’m not against active management. But you can actively manage within a predetermined asset allocation, and based on the experts this active method of asset allocation is also dead. So, let’s apply a little commonsense.

A phrase that all of us have heard, and which is already in a previous post of this blog, describes in easy to understand terms the process of asset allocation.

Don’t put all of your eggs in one basket!

Everyone thinks that advice is no longer valid, it’s dead. Investment management is not a short-term venture. Ignore the noise and the naysayers, it is times like these when the snake oil salesmen make a very good living.

Speaking of “ignoring the noise”, try Mike Piper’s excellent blog and book, The Oblivious Investor. He advocates indexing more aggressively than I do, but his blog and book are both well-written and you might enjoy them.

As always, remember that:

Money is not your life. It is simply the means to the life that you want!