The Float

BrightScope and Vanguard

Two weeks ago, Vanguard's Steve Utkus posted a thoughtful, if not quite fully informed, take on the work of our friends at BrightScope.*

We encourage you to read Steve's original post here.

Then take a look at Ryan Alfred's response at BrightScope's blog.

We're pleased to see these types of exchanges. They should help everyone who cares about the future of retirement security in this country understand what is being done well and what can be done more efficiently and effectively.

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* Full disclosure: Interlake has believed in BrightScope's basic approach from the outset and we subscribed to their Advisor Central service in October, 2009. We want them to succeed, we believe they will (more to the point, we see that they are succeeding), and we think their data and related services can help us bring a truly fiduciary approach to retirement plan participants at companies of any size and shape.

"How are we at counterinsurgency?"

More good stuff from Tom Toles...

A Toles Performance Bonus

The guy's just too good...

A New Slug of Active ETFs

This morning's Wall Street Journal features an Eleanor Laise article on a few new entrants in the category of actively-managed ETFs. We aren't crazy about the concept, largely because we think ETFs work best as part of a strategic asset allocation program with rock-bottom expenses. Here's a telling passage on that front:

Many investors are attracted to ETFs because of low costs. But the new Grail funds will each charge annual expenses of 0.89% of assets, making them pricier than three-fourths of the ETFs tracked by investment-research firm Morningstar. Grail American Beacon Large Cap Value charges 0.79%, only marginally cheaper than the 0.83% charge by investor shares of the nearly identical American Beacon Large Cap Value mutual fund. And the Dent Tactical ETF charges 1.56%. That is more than the average diversified U.S. stock mutual fund.

Roughly one quarter of ETFs have explicit annual expenses of more than 0.89%? Yikes. Then there's this:

Investors haven't flocked to actively managed ETFs. The Grail American Beacon Large Cap Value ETF has roughly $3 million in assets, and the five active PowerShares products have just over $24 million combined.

Brutal. If those numbers don't change soon, these little experiments won't last much longer. What about early returns from these things?

Performance that has lagged behind hasn't helped. PowerShares Active Alpha Multi-Cap Fund is down 21% in the year ending Monday, trailing the Standard & Poor's 500-stock index by 11 percentage points. PowerShares Active AlphaQ Fund is down 3.6% over that period, while its primary benchmark, the Nasdaq 100, gained nearly 4%.

Not a pretty picture. But some sponsors appear undaunted.

Despite the challenges, active ETF providers are aiming high. Grail aims to launch 24 to 30 new active ETFs over the next year or so, said Bill Thomas, the firm's chief executive. And over the past year, the firm has been talking to conventional actively managed mutual funds about converting to an ETF structure.

That's an interesting concept. Many of Vanguard's ETFs are simply different "share classes" of the firm's traditional mutual funds. We'll stay tuned to see if other open-end managers try to break in with ETF versions of their actively-managed funds.

UPDATE: ETFs are growing quickly, but they still occupy a small corner of the investment world. Here are a couple 2008 posts comparing ETFs and index-based vehicles to actively-managed, open-end funds:

• "ETF and Mutual Fund Data: A Reality Check"
• "ETFs and Index Funds: Still Modest in Most Categories"

Source

Eleanor Laise, "Grail's ETFs Take 'Active' Approach," Wall Street Journal, September 30^th, 2009

Independent Advice

Playing catch-up here with a September 14^th InvestmentNews story on the fate of a Bush-era proposal concerning the delivery of advice to retirement plan participants. Here's Sara Hansard's opening riff:

The Department of Labor is killing a regulatory change issued in the last days of the Bush administration that would have allowed brokers affiliated with mutual funds, brokerage firms and other companies that sell investments to provide investment advice to 401(k) participants.

With legislation pending in the House, and the possibility of similar provisions emerging from the Senate, it's likely that the current Congress will act on the question of independent advice. The immensity of the health care reform effort has pushed other things aside for a while, but even if it happens in 2010, and whether it's a product of Congress or the DOL or both, the rules on advice are going to change.

Meaningful legislation on independent advice would help our firm, but our support for these ideas doesn't follow from our firm's position in the marketplace. Instead it's the other way around: Our support for these ideas explains our firm's position, as we wouldn't be in this business if we couldn't do it with absolute independence. 

This is a story worth following.

Source

Sara Hansard, "Labor Department nixes Bush OK to let brokers advice 401(k) plans," InvestmentNews, September 14^th, 2009

BrightScope in USA Today

We were pleased to see our friends at BrightScope featured in yesterday's USA Today story on the high and hidden fees that plague so many retirement plans. This marketplace is changing, and very much for the better.

Fiduciary service providers, sponsors, and participants need to work hard to ensure that defined-contribution plans give participants and their beneficiaries the best possible chance of a decent standard of living in retirement. 401(k) and other DC plans aren't the only piece of the retirement puzzle, of course, but they're immensely important, and there's no reason we can't effect lots of positive change over the next few years.

Line of the Day

Heard on yesterday's installment of Fast Money:

Pete Najarian: "Why did Freeport-McMoran today get put on the Conviction Buy List over there at Goldman Sachs?"

Karen Finerman: "Because they were long already."

Good stuff.

Agility Matters

We've long argued (here, here, and here, for example) that most big mutual funds are a rotten deal for individual investors. Due to their size, trading costs, and diversification, many of these funds end up behaving like very expensive index-trackers over full market cycles.

Most of the evidence we've pointed to has focused on big, lumbering laggards. Yesterday's Wall Street Journal featured a story on the best-performing funds in the first half of the year, and the upshot is clear: Small is beautiful.

While their names mightn't be familiar to many investors, there were some stock funds that delivered stellar returns over the past year.

Among the seven best-performing funds in the 12 months to July 31, none is from the 25 largest mutual-fund companies and none of the funds has more than $700 million in assets, according to data from Morningstar Inc.

Despite the market downturn that saw the Standard & Poor's 500 Index lose 22% during the 52-week period, the seven funds, all of which invest in long-only securities and are mostly invested in stocks, have seen double-digit returns.

Six of the funds use "value" strategies, while four have concentrated portfolios and held fewer than 40 stocks, according to the most recent data. The figures suggest investors should take note of smaller funds, if nothing else than for their ability to be more flexible in challenging markets.

Indeed.

Source

Sam Mamudi, "Top Funds' Traits: Strategy and Size," Wall Street Journal, August 6, 2009

BrightScope on 401(k) Legislation

The center of gravity on 401(k) legislation has long been the office of Rep. George Miller (D-CA), who chairs the House Committee on Education and Labor and has taken great interest in issues relating to retirement security in general and defined-contribution plans in particular. 

Miller is the lead sponsor of H.R. 2989, which combines fee disclosure provisions with a requirement that investment professionals providing advice to retirement plan participants be genuinely independent. All of which sounds good to us. And to our friends at BrightScope, where Ryan Alfred has posted a comprehensive assessment of H.R. 2989's investment advice component. Here's Ryan's conclusion:

It should be the intent of the legislation to align the standard of care of financial representatives with the expectations of investors and to strengthen investor protections. If "harmonization" is to occur it needs to be the harmonization of investor expectations with the standard of care of their advisers, regardless of whether that financial firm was heretofore regulated as a broker-dealer or an investment adviser. That means upgrading all providers of investment advice to the existing fiduciary standard for investment advisers, not lowering the fiduciary protection via a new "federal fiduciary" standard. Nowhere is this case more clearly evident than with retirement plans, where a higher percentage of investors are unsophisticated and lack the freedoms they have in non-retirement accounts. These investors deserve to have access to conflict-free advice from fiduciary advisers.

We second that enthusiastically.

A Faster Lost Decade?

Is the United States economy headed for a Japan-style lost decade? Evoking our February, 2008, item "Faster Markets," Slate's Daniel Gross suggests that the deep, ongoing recession in the United States may unfold much more quickly than Japan's analogous bubble-bust of the 1990s. This is good stuff:

Why the accelerated pace? It has to do in part with changing global circumstances. Nishimura argues that both crises started because problems in the property and credit markets contributed to an adverse feedback loop between financial distress and economic activity. But information, events, and distress move much more quickly around the globe today than they did in the 1990s. With just-in-time production systems, and with 21^st-century communications technology, bad news travels much more quickly--and farther. In the 1990s, much important exchange of international market information was still done by fax. In addition, traders can now act more quickly on real-time bad news. In the early 1990s, analysts had to wait several months for data. And since the level of financial integration was much less intense in the early 1990s, Japan didn't export its financial problems.

The upshot: In the current crisis, "the velocity of market dysfunction has been much faster and its contagion much more widespread than in Japan's case." And so the damage has been more devastating.

Of course, the duration of the crisis also has something to do with the mentality and action of the first responders. A lesson from both crises, he argues, is that once an adverse feedback loop is established, it's difficult and very expensive to break it and restore confidence. It took a very long time for good news to reach critical mass in Japan in the 1990s, in part due to the slowness of the policy response. But this time, it's different. The Federal Reserve--and, indeed, global central banks and governments--have responded with alacrity. Japan's central banks didn't adopt a zero-percent interest-rate policy until more than eight years after the crisis started; the Fed did so within 20 months. It took Japan nearly eight years to inject funds into troubled banks, compared again with 20 months for the United States to do so. And, Nishimura argues, efforts like the stress tests and TARP exits are bolstering confidence.

Read the whole thing. It's excellent.

Source

Daniel Gross, "A Recession in Dog Years," Slate, June 24, 2009