Evaluating Managed Funds

[buffett]

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If you're going to quote the 10Q, please quote all of it. "During the first nine months of 2005, the value of most foreign currencies decreased relative to the U.S. dollar. Thus, forward contracts produced pre-tax losses in 2005 of $897 million for the first nine months." It is widely known that Buffett lost $1B last year shorting dollars.

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That's fine, but $2.1B - $1B = $1.1B.

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non-dollar investments might make sense as a long-long term issue, but as a short term macro factor, you can be dead wrong...Over the longer run, you will see a weaker dollar reflected in the form of more expensive imports, and possibly, inflation, but from Ed's point of view, dollar investments arent necessarily a bad thing short term.

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Then perhaps you shouldn't have invoked Mr. Buffett's position to make your point, as it is a famously long term one.

[Derek in NYC]

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If you're going to quote the 10Q, please quote all of it. "During the first nine months of 2005, the value of most foreign currencies decreased relative to the U.S. dollar. Thus, forward contracts produced pre-tax losses in 2005 of $897 million for the first nine months." It is widely known that Buffett lost $1B last year shorting dollars.

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That's fine, but $2.1B - $1B = $1.1B.

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non-dollar investments might make sense as a long-long term issue, but as a short term macro factor, you can be dead wrong...Over the longer run, you will see a weaker dollar reflected in the form of more expensive imports, and possibly, inflation, but from Ed's point of view, dollar investments arent necessarily a bad thing short term.

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Then perhaps you shouldn't have invoked Mr. Buffett's position to make your point, as it is a famously long term one.

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Look, the big picture is this. Ed said "How do I choose MFs in an IRA rollover?" Somebody said "Avoid dollar investments." Evan said "That's a smart point." Somebody said "Yeah, Buffett is short dollars."

Now Im saying, "Dont think you can get the macro call right just by following Buffett. He was wrong in 2005 in a huge way."

For an individual investor to make investment decisions based on getting the macro call right (and the timing of that call also), is folly. Just take an efficient frontier approach (or an index approach) to investing, or give your assets to a professional manager who you think can beat the index and/or make the right macro calls.

Buffett is right long term, no doubt, and he may be right long term with his dollar bet, also. But that doesn't help an investor like Ed, who is looking to make yearly re-allocations.

[buffett]

Yeah, those are all good points (except I would say Mr. Buffett should not be considered "wrong" just b/c his long-term trade fluctuated against him during calendar 2005).

I thought our assumed horizon was long-term. I had no idea that the following quote was true, and--if it is--then I would like to encourage Ed to reconsider:
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Ed ... is looking to make yearly re-allocations.

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[Derek in NYC]

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Yeah, those are all good points (except I would say Mr. Buffett should not be considered "wrong" just b/c his long-term trade fluctuated against him during calendar 2005).

I thought our assumed horizon was long-term. I had no idea that the following quote was true, and--if it is--then I would like to encourage Ed to reconsider:
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Ed ... is looking to make yearly re-allocations.

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Well I dont know for certain that he is, but yearly re-allocations with MFs really isn't a bad idea for normal investors. For instance, I sold down my emerging markets exposure this January b/c the funds did so well last year, from an asset allocation POV it didnt make sense to stay long EMs as much as I was.

[rockrock]

DesertCat and Buffet,

Since I didn't go to Wharton, I assumed 44% annualized returns meant 44% over the 4.5 years. BRSIX is a tax-managed index fund that annualized 28%+ AFTER TAX returns for the same time period and 10k would have grown to around 30k. A far cry from your 58k or whatever. I would suspect that with capital flowing into this asset class that your returns in the future will be more benchmark hugging. Time will tell I guess.

As far as the 1% versus 100% thing - I still can't believe you are asking the question seriously.

Why do you think Icahn and those guys start demanding board seats when they take a position in a company?

Why do you think these companies pay millions of dollars in legal fees for poison pill remedies to stop hostile takeover bids?

How do you explain Eddie Lampert and KMart?

The answer is self-evident. These guys are investors that can lock up board seats, influence management and unlock shareholder value through sweeping changes in corporate governance, selling off individual assets, etc.

The rest of us trade electronic shares of companies. We cannot exert this kind of influence because we don't have enough money to get anyone's attention.

Kudos on your small cap outperformance. You have done this in what most would consider the most ineffecient asset class tradeable in the public equity markets but have handily beat all the good actively managed micro-cap funds I am familiar with. Good luck in the future.

[rockrock]

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I thought our assumed horizon was long-term. I had no idea that the following quote was true, and--if it is--then I would like to encourage Ed to reconsider:
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Ed ... is looking to make yearly re-allocations.

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Rebalancing is an important part of Modern Portfolio Theory.

[DesertCat]

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DesertCat and Buffet,

As far as the 1% versus 100% thing - I still can't believe you are asking the question seriously.

Why do you think Icahn and those guys start demanding board seats when they take a position in a company?

Why do you think these companies pay millions of dollars in legal fees for poison pill remedies to stop hostile takeover bids?

How do you explain Eddie Lampert and KMart?

The answer is self-evident. These guys are investors that can lock up board seats, influence management and unlock shareholder value through sweeping changes in corporate governance, selling off individual assets, etc.

The rest of us trade electronic shares of companies. We cannot exert this kind of influence because we don't have enough money to get anyone's attention.

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I don't disagree with any of your points here. But we were talking about Fama's attempt to explain Buffett's outperformance. Since Buffett doesn't "unlock shareholder value through sweeping changes in corporate governance or sell of individual assets", how does having control make his 100% investments any different than his 1% investments?

Almost every acquisition Buffett has made is still run by the same management team (or their children!), with very little interference or even contact with Buffett. They simply write him quarterly checks from their free cash flow.

In fact, one of my few disappointments with Warren Buffett is that he isn't more activist. When he realized who Eisner really was, he didn't wage a proxy battle to fix Disney's outrageous executive compensation, instead he sold. Even with all his influence, he's let Coke management get away with some very questionable decisions in the last decade that run counter to his basic philosophy.

Warren's success was built through stock picking and I haven't seen any arguments from Fama to prove otherwise. I would guess the percentage of his portfolio that's been invested outside of basic stocks and bonds, or in a control situations where he took an active role (Sitel in 1959 for example) has been much, much less than even 10% on average in the last 50 years.

You might be right that more money is flowing into the microcap market, but I'm hopeful to still outperform for several reasons. First, is that it's a hard place to put much money to work, so it's simply not interesting to most professionals. I found a new idea that's a great value, but it trades $6k per day! That's too small for even a 2M portfolio. But if you are a professional, you probably need a fund larger than $10M just to pay salaries and office expenses.

Secondly, there is a skill to stock picking. Hopefully I continue to learn and get better at it, and have an edge over most of my competitors. At least I hope so, so I don't have to go find another job But guys like Buffett have been skillful enough that they started where I'm starting and continued to outperform as they move up into less efficient asset classes, which is the path I hope to follow.

[DesertCat]

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Now Im saying, "Dont think you can get the macro call right just by following Buffett. He was wrong in 2005 in a huge way."
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Buffett is right long term, no doubt, and he may be right long term with his dollar bet, also. But that doesn't help an investor like Ed, who is looking to make yearly re-allocations.

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I believe the dollar rebounded last year because of the "repatriation window" the U.S. congress opened for foreign profits of domestic corporations to be returned to the U.S. It appears the amount of profits repatriated was larger than the U.S. budget deficit in 2005.

But the repatriation period ended, and we are still running large deficits. If you believe Buffett's theory, you would expect to see the dollar start devaluing again and continue until the U.S. deficit is substantially reduced. Interestingly, but far from proof of anything, since the repatriation window closed in december the dollar has declined against the euro, yen and pound.

So how that affects Ed or anyone who wants to take a passive approach to investing is, that you should be concerned about the real buying power of your portfolio. You should probably make a reasonable allocation to foreign index funds, anywhere from 20-35%. Note that this isn't much different advice than is normal, i.e. you should always have some allocation for international stocks. I'm just saying that if you believe Buffett's theory, you should make that allocation larger.

One other thing to consider if you want to do some research, is how large are U.S. deficits compared to the countries represented in your choice for a Intl. fund. I.e. if those countries are running proportionately similar or even bigger deficits, than you have to question whose currency will relatively devalue. So far I believe we are still solidly outborrowing most large asian and european nations, if that's true the basis of the Buffett theory still holds.

[Evan]

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So far I believe we are still solidly outborrowing most large asian and european nations, if that's true the basis of the Buffett theory still holds.

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We borrow roughly 80% of the world's savings. We're outborrowing everyone.

This all leads back to a USD crisis. Nile Ferguson, quoting Kent Smetters, said that the PV of the US net debt (PV of all future revenues based on current tax policy - PV of future expenses based on Social Security, medicare and the fiscal deficit) is ~$40 Trillion. To put that number in perspective, if you bought every share of every stock traded on the NYSE, NASDAQ and AMEX, it would cost you about $15 trillion. To put in in scarier perspective, that number represents about 4x US GDP. Let's say we wanted to take care of this problem immediately, that means that none of us would eat or consume in any way for the next four years.

That 20-35% allocation in foreign assets needs to be more on the order of 50-65% imo.

Edit to note that a likely "solution" is that people entering the work force today (i.e. me) will face likely twice the tax rates our parents did.

[rockrock]

DesertCat,

Good luck to you this year keep us posted with your results. You killed brsix last year but finished on par with some of the better actively managed microcap funds.

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Almost every acquisition Buffett has made is still run by the same management team (or their children!), with very little interference or even contact with Buffett. They simply write him quarterly checks from their free cash flow.

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I don't know much about Buffet other than what I've heard or the little I've read but I do know that large ownership stakes are different from smaller "investors" for the reasons I've cited.

I also know that no fund manager has been able to replicate his success, so he is either the ultimate statistical freak or the superinvestor stock picking machine you guys claim (doubtful) OR his positions enable him to influence the way a company is run.

There is one mutual fund I find intersting that trades more like a hedge fund - CGMFX - CGM Focus.

I think this is a great fund for someone with only a little money to invest that wants to take a shot at really outperforming the market.

Ken Heebner is allowed to go short and so things most managers aren't. He is aggressive and seems to know what he is doing. If I had a small 401k, it would be the only fund I owned until I had a decent sized portfolio.