Maryland's $37 bln. Pension System Earns .36%

 How did your investments perform over the 12 months ended 6/30/2012?

Maryland's $37 billion state retirement and pension system for employees and teachers earned .36% over this period.

Last week CALPERS, the country's largest public pension fund, at $233 billion, reported a return of 1% for the 12-month period ended June 30, 2012.

 Interestingly, a basic indexed portfolio invested 55% in SPY (S&P 500), 15% in VEU (global less U.S.), and 30% in AGG (U.S. investment grade bond market) would have returned 2.6% before fees.

The difference between .36% and 2.6% for the $37 billion Maryland pension fund amounts to $828 million.  That would go a long ways toward paying Maryland teacher pensions.

I have to agree with Jeff Hooke, Chairman of the Maryland Tax Education Foundation, who said the results "look like a minor disaster for fiscal 2011."

Source:  MarylandReporter.com Md. pension system earns close to nothing in past year by Len Lazarick

How Do Broker Stock Picks Do?

Source: Capital Pixel

In previous posts, I've described the process of picking a purported market beater as similar to trying to pick a blue marble out of a jar where 80 marbles are red and 20 marbles are blue.  After all costs are taken into account, this represents roughly the odds that picking an actively managed fund will outperform its index.  This holds across various asset classes, time periods, and even countries.  It is undoubtedly why investors are flocking to low-cost, well-diversified exchange traded funds and why the exchange traded fund market which has been based on index product has seen explosive growth.

From a different angle, I run into DIY investors who tout the research of their brokers or of someone they follow on CNBC. And, admittedly, judging by the length of research reports, the number of complicated colored charts, and metrics presented, the reports are impressive - both for fundamentalists (those who focus on balance sheets and income statements) as well as technicians (those who focus on visual patterns).
 
But the question doesn't change - do the picks add value?

The results of an ongoing study by Barron's - Zack's spreads light on this question and is described by Vito J. Racanelli in The West Coast Was the Right Coast.

The study examines the stock picks of 9 brokers over various time periods.  The longest period over which all 9 were included was 3 years.

The following table shows their results for the 3 year period:

Broker	3 Years
Wedbush Securities	81.05%
McAdams Wright	63.49
BoA/Merrill Lynch	62.95
Edward Jones	50.97
Goldman Sachs	50.69
Morgan Keegan	48.15
Morgan Stanley Smith Barney	46.31
New Constructs	45.35
Charles Schwab	43.21
Average Broker	54.69
S&P 500 (With Divs)	57.70
S&P 500 (Equal Weight)	70.35

The bottom line conforms with other lines of research.  If you feel lucky, go with the broker picks but recognize there could be a hefty cost if your rabbit's foot doesn't hold out.

There are other interesting results that can be gleaned from the study.  The winner over the 5-year period was McAdams Wright with a return of 14.12%.  Should you have gone with them?  For the most recent six months, they are at 3.95% versus 9.49% on the S&P 500.  Ooch!  As with previous research, consistency is an issue.  Playing the hot hand can be costly.

401(k) Fee Disclosures

The Department of Labor rules requiring 401(k) fee disclosures finally become available on the fall 401(k) statements.  Participants will see fees for the first time for administrative expenses as well as for investment management.

Smaller plans with less participants tend to take a bigger chunk out of the bottom line.  These plans, of course, tend to have the least sophisticated administrators.  In fairness, it should be noted that the larger plans do enjoy economies of scale; so their costs on a percentage basis should be somewhat less.  CNNMoney reports the following figures based on BrightScope data:

Total Assets                  average # of participants              Fees

> $1 billion                             53,650                                     0.36 %

$100 mln. - $1 bln.                       6,324                                     0.53 %  

$10 mln. - $100 mln.                       858                                      0.85 %

< $10 mln.                                    42                                       1.40%  

 Source: p.16, Money, August 2012

FYI:  A fee of 0.85 compounds to 13.5% over 15 years.  Thus, rolling over $10,000, say, to a 401(k) with these expenses could take out a good chunk of the nest egg over time.

401(k) participants will want to use this information to determine how to allocate their retirement contributions and make fund rollover decisions.  Generally, they will want to take advantage of any company match.  After that it may make sense to fund an IRA and use low-cost, diversified funds.  One outcome will likely be a general lowering of expenses as competition kicks in.

IMHO, it is a shame the government has to pass a law requiring this information.  Administrators should have insisted on it up front.  Once a few big providers got the message, it would become standard practice.          

Sandy Weill and Other Stuff

Yesterday Sandy Weill cleared his conscious and stunned the financial world by saying that he believes we should move back towards Glass-Steagall by separating commercial and investment banking.  This amounts to an admission that the banking supermarket he played a major role in creating was a huge mistake and that it created "too big to fail" behemoths that are harming the economy. Maria Bartiromo went apoplectic as she is wont to do, and politicians were trotted in front of the cameras to proclaim that it was a great idea worth considering.

Unsolicited advice to politicians:  keep your mouths shut.  Every time you open your mouths, you prove that you can't think for yourself.  You show that you are puppets spouting the party line, and you are pushing voters into the camp intending to vote across the board against incumbents.

Wouldn't it be something if Sandy Weill's McNamara moment will get Greenspan to admit that micro-manipulating the price of money via the federal funds rate was a mistake and caused the housing crisis leading to the Great Recession of 2008?  That would get me to go apoplectic.  Greenspan, in the '90s until the end of his tenure, and Bernanke today micro-manipulated this price.  Today it is at zero %, and markets are debating whether the Fed has any means at all to improve the economy.

What tends to be swept under the rug is that the Fed totally botched its mandate of ensuring a stable banking system, completely misunderstood the housing market debacle, and didn't understand the banking sector was in a solvency crisis rather than a liquidity crisis.  Other than that, they did a terrific job.  Banks loaded up on off-balance-sheet toxic debt as the FOMC focused on pontificating on their views of the likely course of the economy.

Speaking of forecasts - this from Ezra Klein in Why not Uncle Ben's Crazy Housing Sale?:

In January 2010, the Fed projected that the economy would grow 4.15% in so12.  By June 2011, it had revised that down to 3.5%.  By April 2012. it was down to 2.65 percent.  And in June, officials lowered expectations once again, saying they expect economic once again, saying they expect economic growth to be a mere 2.15% in 2012. Ouch.

Klein's article is worth reading because it illustrates so well how top analysts and observers fail to understand economic fundamentals.  Here is fundamental number 1, presented in the first week of Econ 101:  manipulating prices distorts resources.  This can be seen in the minimum wage market, rent control market, and even the Nixon price controls.  It is especially true for the price of money via the fed funds rate.

Lowering the fed funds rate to 1% in 2003 led to a moonshot in the housing market.  Resources gushed into housing.  People became mortgage bankers, real estate agents, carpenters, etc.  That's what prices do.  Then the Fed pushed fed funds above 5% - in effect, saying we didn't need all of the resources that had moved into real estate activities.  Think about this.  Today they wonder why it is so hard to get unemployment down.

As you read Klein's article and see that he supports buying mortgages and pushing down the rate on 30-year mortgages (again, affecting the price of money), you'll probably scratch your head.  This is exactly what got us into the present situation.

They say a definition of insanity is doing the same thing over and over and expecting a different result.

How about a different approach:  set a growth rate for M1 or M2 of 3%/year and let the market set interest rates, i.e., set the price of money.  Volcker did this, and it broke the back of spiraling inflationary expectations.

Joe Learns About Risk - In the School of Hard Knocks

Suppose you had enough money to put in Treasury notes so that you could live off the interest.  Would you be set for a risk-free, secure retirement?

You probably have guessed that the answer is no.  I found over the years, however, this wasn't an easy argument to make.  There were people who would show me their portfolio - 100% U.S. Treasuries - and explain that they could retire on the interest.  They would then say that they were taking no risk.

This is where the professional can add value.  He or she points out that there are different kinds of risk. Granted that U.S. Treasuries have zero credit risk, but they do have interest rate risk, reinvestment risk, and inflation risk. Let's examine this.

Joe - the First 10 Years

Let's go back 20 years.  Let's meet Joe, a composite of many who have approached me over the past 20 years to talk markets and investment strategy.  Joe explained that he didn't have to take risk because he had diligently saved and now, in 1992, had his assets all in the 10-year Treasury note throwing off $40,000/year.  Along with Social Security, he was looking forward to a great retirement.  Joe was 60 years old.

In 1992 the 10-year Treasury note yielded 6.73%.  Joe had $595,000 invested in 10-year Treasury notes to produce $40,000/year income.  In 2002, when the 10-year Treasury matured, the yield on the 10-year was 4.49%.  Now his $595,000 was producing $26,715.  Uh oh!

But this wasn't nearly the whole story.  Inflation had eroded the value of the dollar over this 10-year period to $0.78!  Thus, the $26,715 was equivalent to $20,837!  Thankfully, his Social Security had kept up with inflation; but, sadly, ten years into retirement and Joe had to change his lifestyle in a big way.

As an aside, you see a lot written about retirees running out of money.  In real life, what happens is they change their lifestyle.  In other words ,if they make mistakes, then it means they don't eat out as often, take the trips they planned, repair the roof, etc.

Joe - the Next 10 Years 

The ensuing 10 years saw Joe's position deteriorate even more.  Today he has his Treasuries maturing and the reinvestment rate is 1.43%.  Furthermore, inflation has significantly eaten into the real spending power of his Treasury Note interest.  Joe is 80 years old and in a precarious position.

Conclusion

I tried to explain to Joe when he was 60 years old that there are different types of risk.  I suggested (pleaded, in some cases) for him to put at least 30% in a well-diversified equity portfolio.  I tried to explain that, by doing so, he actually reduced his risk.  Incidently, $100,000 in equities would have grown to approximately $400,000 today.  But, my advice to Joe was mostly to no avail.  He had his mind made up.

Today, of course, I see people all the time who have their money in money market funds.  Some are fully invested in CDs.  They tell me they don't want to take risk.  Some things never really change.

Kiplinger Quiz "Are You Saving Enough For Retirement ?"

Take this short quiz to see how you stack up against over 32,000 others who have taken the quiz.  This quiz is part of an article by Mary Beth Franklin, Don't Run Out of Money in Retirement.

A couple of points in the article worth mentioning.  First, recent research by Webb and Wei Sun of China's Remin University found that basing withdrawals on the required minimum distribution approach set forth by the IRS may be optimal.  RMDs are required at 70-1/2 and are based on an individual's life expectancy.

A second point, made at the very end, is that rules of thumb can be dangerous.  The withdrawal rate needs to be constantly reevaluated.  For instance, for much of the period over which studies are performed, bond prices rose as stocks declined.  In other words, bonds acted as a hedge.  Today markets face yields at historical lows, and the possibility exists that both fixed income and equity markets could decline at the same time over a protracted period.  This is just one significant way that the present environment differs compared to the past.  Others include medical costs and globalization.  The point is to reevaluate at least yearly.

Stocks Yield Higher Than Bonds and Other Stuff

According to Jeff Erdmann of Merrill Lynch, the average yield of Pepsi, Intel, Johnson & Johnson, Procter & Gamble, and McDonald's is 3.29%, 1.2% greater than the average yield on these companies' 10-year bonds at 2.09%.  After taking into account the favorable tax treatment of qualified dividends, the stocks yield 2.79% compared to 1.36% on the bonds which are taxed as ordinary income.  (Source:  Barron's, 7/23/2012, p. 28).

From the Pension Fund world:  According to Michael Aneiro, "Top Pension Fund Sends a Warning", Barron's, 7/23/2012. p. M9, CALPERS, the country's largest public pension fund at $233 billion, achieved a return of 1% for the 12-month period ended June 30, 2012.  Interestingly, 55% in SPY (S&P 500), 15% in VEU (global less U.S.), and 30% in AGG (U.S. investment grade bond market) would have returned 2.6% before fees.  That's an extra cool $3.7 billion--not to mention that big-time managers scraped off a hefty amount in fees and the huge staff maintained at the Fund.

Finally Europe:  Bloomberg Businessweek (7/23/2012, p.9) reports that the European Court of Justice ruled that workers in the European Union "are entitled" to another vacation if they get sick on vacation. Is this an incentive to, in fact, "drink the water"?