Saturday, November 28, 2009

You buy insurance on your possessions and your life why not your investments?

I’m writing this blog on Black Friday as the world markets came under pressure with the problems in Dubai loan payments. The leaders are saying this is an isolated problem and the amount at risk is no problem for the word markets. We heard that same statement made about the US real estate market two years ago. I don’t know if there is a bigger problem, but I have learned that where there is smoke there is fire. Only time will tell how serious the problem turns out to be.

Just think, if you bought gold on Wednesday you are down $33 in two days. Most of the global stock markets are off 3% to 5%. Here is the question for consideration: Is this the correction the markets have been looking for or is this a dip and in turn a buying opportunity? It is somewhat ironic that we set a 14-month high on the Dow Jones at the close of business on Wednesday and then had this correction. It is possible the Dubai problem becomes the event that takes some of the froth off the market and causes people to rethink the valuations of the market.

The significant amount of volatility in the markets raises questions. How can I protect myself when prices fall on stocks and bonds without selling and going to cash? which is paying nothing). One of the trade offs in making the sell decision is: If I sell a stock that has a current yield of 8% and then invest in a money market fund earning close to zero I’m giving up a significant amount of income.

It is possible, to some degree, to protect yourself on the downside. There are many ways to buy this insurance; some insurance is short-term while others can be left in place for years. For most of my clients I tend to use insurance that has no time limit. One form of short-term insurance is options. Options give you the right to buy or sell your stock for a price for a specific time frame. The problem with this form of insurance is that stock options are for a specific stock and while it may give some insurance on one specific stock it can’t give you protection on an entire portfolio of stocks and no protection on bonds. You can trade futures on both stock and bond markets but again, for the most part, they have a specific time frame.

I want longer-term protection that gives me the longest times frame and covers the broad stock and bond markets. I have found that using Exchanged Traded Funds (ETF) for both the S&P 500 and the bond markets gives me the greatest flexibility. I understand that some people think that these short ETF’s should not be allowed. They believe that people do not understand the risk of these investments. I could say that many people do not understand much of the risk they are taking with their investments.

I use the SDS, ETF for insurance on the downside for the S&P 500 and the SSO ,ETF for the long side of the market. In the case of Treasury bonds I use the TBT, ETF to buy insurance on the short side of the fixed income markets. Let me point out that I’m not trying to time the markets; I know that markets go up and down and they don’t do this in a fixed manner. I may have to hold on to a long or short position for an extended period of time before I sell. Here is the point. If I’m short the market with the purchase of the SDS and the market goes up, then hopefully my stocks will go up and my ETF will fall in value. When the markets turn and stocks fall then my SDS will start to increase in value. Just like insurance on your home you hope you never have a claim but if you do have to file a claim then you feel good about having the protection. The use of long and short ETF’s can give you long-term protection and most importantly reduce the volatility of your investments. Don’t you wish you could buy insurance on the declining value of your home? You can, the symbol is HPB.

Dan Perkins

Friday, November 13, 2009

10.2 Unemployment May Be The Death Knell To The Money Market Fund Industry.

On Friday November 6, 2009 the unemployment rate was reported at 10.2%. The markets were expecting double-digit unemployment, but not till sometime in the first quarter 2010. The result of the unemployment number may well be the demise of the money market mutual fund industry. TD Holdings, the third largest retail brokerage by client assets, reported last week that the fee waiver for their money market mutual funds impacted the earnings results in perhaps the biggest bull market in 80 years. Can other brokerages like Charles Schwab be far behind in reporting similar results impact on earnings through fee waivers?

Charles Schwab reported in its third quarter earnings report that money market fund fee waivers increased to $78 million through the end of the quarter resulting in a 24% decline in overall revenue. Randy Merk, CIO of Schwab expects that there will be $200 million in fee waivers for 2009. He further said that if interest rates stay low in 2010 he expects that Schwab will report $100 million in fee waivers per quarter next year.

On Wednesday November 5, the Fed Open Market Committee reaffirmed its position when it said that it would hold interest rates low for the dreaded “Extended Period of Time”. The market was hoping for a better unemployment number on Friday and because we are now at 10.2% and probably moving higher the likelihood that the Fed will be tightening next year went out the window and the possibility of return for both managers and investors alike. The estimates for the peak in unemployment will have to go up as economists were looking for a peak in second quarter 2010 at around 10.5%. Some are predicting that we may go above the post World War II record that was 10.8 in 1982.

For most of this year money market mutual funds managers have been under pressure by outside directors to do whatever was possible to hold the net asset value (NAV) of money funds at $1.00. The vast majorities of both US Government and General money market funds have waived most of their management fees and managers are now paying some if not all of the other operating expenses to hold NAV at $1.00 even if the return is near zero.

If near zero return is not bad enough for regular money market mutual funds, according to the Investment Company Institute (ICI) in a recent report there is also over $1 trillion dollars in separate account variable annuity and variable life products that are losing money. The ICI reports that approximately one third of the separate account assets are in money market accounts. If you look at the Wall Street Journal report on separate account performance ( you will find, net of mortality and expense fees, all these accounts are losing money. Some separate accounts cash accounts are showing losses as much as 1.60% on a seven-day yield basis. If you look at cash account values in separate accounts you will see that they are declining. People are loosing money on cash investments.

Because of the employment data the short end of the bond market saw the yield on 90-Day T-Bills fell to 3 basis points. All of the money funds are trying to shorten their duration and therefore they are becoming the victims of their inability to accept that the money market mutual fund business model is broken. Time is wearing them down along with the loss of income.

Many of the US Government money funds are closed to new and sometimes existing investors can’t add money. I have noticed that some general money funds are beginning to close so no new money can be added to existing accounts. The enormous stock market rally has taken the spotlight away from the problem of no return on cash. When the stock market has a serious correction and investors want out of equities, where will they go? Those investors in separate account investments will see their losses continue when they get out of stocks and go to cash. Cash at zero return will not be acceptable; cash at negative returns is even less acceptable.

I think return of invested capital is in the offing for many money market mutual fund holders especially the smaller funds. The asset management companies will have to come to grips that after the first of the year they could be looking at perhaps two more years or more of no fee income from whatever is left in the money market accounts. The idea of no income will not be acceptable and they will want to find ways to get out of the business. Closing funds and distributing assets is the quickest way out of the business. It is possible that some management companies will break the buck and use the cover of the prospectus language of potentially loosing money and look to keep whatever money they can on their terms.

If you think about the customer earning zero percent on money market funds when they could earn at least 3 to 4 basis points on a direct purchase of T-Bills the fund industry has to ask if they are doing the best thing for the clients. As advocates for the client investment advisors have to help clients get the most on their money with the least amount of risk.

The problems of making little or no income on market mutual funds and separate account cash investments require both industries to rethink their business model. I believe that the new model will see the NAV of $1.00 disappear and people will be exposed to the potential of losing money. I think both the managers and the investors will continue to loose money until reality sets in and true business decisions are made.

Dan Perkins