Disruptive Investing

Exchange traded funds (ETFs) are all the rage. They come large and small, long and short, ultra and supersized, and track just about any sector, geography, investing style or commodity you can think of. The great thing is they trade like stocks yet share some of the characteristics of mutual funds (without the massive overhead some mutual funds carry). ETFs are baskets of like stocks in a particular industry or region or index, and so, if you think for example high tech is going to take off, rather than study and research for which particular stocks to buy, jump on a high tech ETF and enjoy the benefits of spreading out your bet. You might not get as high a return as you could have with that one perfect stock pick, but then again, you have to be a really good stock picker while also bearing the risks of a less-diverse portfolio. Some say ETFs have lower overhead than mutual funds and perform just as well, because of the reduced fees. Some even say during down markets ETFs fair better t...

Figure 1 (click to enlarge) Now, we have defined mutual funds as digital assets that can be distributed thru a virtual network, from source where the value is created and managed, to the retail investors where payment of fees is made (plus information about self is granted) in exchange for that created / perceived value, via the wholesalers, distributors, financial advisors and institutional investing networks. But not all is simple, mutual fund managers must navigate a stormy sea of: • Redemptions (clients departing) • Performance (NAV decreasing, Cap gains & Dividends decreasing) • Risk (volatility increasing) • Asset Allocation (what’s the right mix?) • Modeling (efficient frontier “what ifs”) • Competition (perception of better & best) • Disintermediation / Transparency? • Reputation (least worst performing?) • Future? - How will they perform relative to their peers and other assets such as Hedge Funds and ETFs (Exchange Traded Funds)? – Independent scoring of “Diversificat...

We're going to build upon our ideas that the financial industry is a supply chain and information and value flow in both directions, inbound and outbound. See our Mutual Fund Industry Supply Chain Model post. The greatest point of value creation is at the portfolio construction stage (creating and maintaining that list). Preservation of that value (capital) must be supported across the supply chain. Propagation of that value can be diluted when repackaging occurs, that is, when mutual fund wholesalers and distributors (middle men) and financial advisors create bundles of mutual funds with other assets that change the expected returns, diversification, volatility and relative performance, while also adding on expenses and fees, directly charged against the capital. Pervasive technology, proven processes, and experienced people, at all stages assures value, preservation and risk control, or at least, it should. Because of time periods and variability, regeneration (maintenance) must...

• Mutual Fund (List of Assets) – Does not have physical size, weight, color – Does have a ‘particular collection’ of virtual assets – The construct of the collection defines the potential for value – It can be sold as-is, repackaged with other funds, grouped with dissimilar asset classes for added diversification and preservation of capital – Hence, the concept of a supply chain can be applied to the distribution of funds (via wholesalers and distributors) and in the reverse to the collection of capital (AUM) and management and distribution fees (loads, premiums, expenses, …) •Fund of Funds (List of Lists) – This is layering cost upon cost, idea upon idea – Value created, perhaps also undermined?

• Mutual Fund (simplified) – A particular collection of financial instruments controlled and created by a manager with fiduciary responsibilities to buyers (it is a list, a virtual asset of virtual assets) Characteristics of this List: • Stocks and / or Bonds and / or Cash (limited to some particular blend) • Focused on particular ‘sector’ (industries and sub-industries) • Controlled by geographic boundaries (regions, countries, continents) • Limited by charter to particular ‘styles’ (think style boxes) • Restrained in types of trades and % Cash (usually no derivatives, shorting, options) • In exchange for the manager (cost overhead), Buyers expect – Preservation and Growth of their capital (above averages) – Returns in the forms of dividends, capital gains distributions, … – Steady, smooth NAV, no surprises, low volatility – Salability / liquidity •Value is “created” by the superimposition of the collective performance of the individual virtual assets as a grouping (lis...

No one wants a transparent money manager, in the sense of not adding value. ETFs and Indexes are available to match performance with market averages. No, we want returns above and beyond those. Funds should have incremental (relative) returns that exceed fund incremental costs, significantly. Otherwise, why would we pay so much for funds? We could compile a list of all funds and their true diversification scores. We could also measure the true Return on Investment (ROI) of each fund's incremental returns. This is not unlike calculating the ratios for publicly traded companies, to assess the performance of one versus another, in making investment decisions. One might say "my fund's ROI was 20%, because I put in $10K and it grew to $12K". Let's assume the market returned 10%. Your $12K is in comparison to $11K, so your relative return is $1K or 10%. If you cash out you'll be paying a redemption fee. You probably paid a sales commission up front and there were pr...

It’s not enough to say you’ve mitigated all your risk in the face of present economic change, but one must be able to quantify, measure and modify it often, in order to stay on the maximum potential return of a chosen portfolio strategy over time periods. Note the emphasis on the plural. The dilemma, to maintain a selection of quality assets on a portfolio's efficient frontier that add incrementally more return while not adding more risk. The problem is that flushing out risk can bring you closer to the market average. Risk-based portfolio optimization schemes, such as Mean-Variance Optimization (MVO) can suffer from unintentional mistakes (decisions made) because MVO tends to weight the historically higher returning assets more heavily, at the expense of ignoring potentially higher returning assets looking forward. In other words, there may be a greater chance that a great performer may no longer perform great, and alternative assets could add a higher return while decreasing the ...

Risk is difficult to measure and to manage. ETFs and indexes exist that provide performance averages. Mutual funds suffer from overhead and management costs, loads and redemption fees. When investors are paying fund managers to reduce risk, minimize volatility and maximize returns, and they realize an industry average, index (which has no management), or T-Bill has bettered their fund, they should be upset. They have experienced an opportunity loss while taking on excessive risk, and while paying people to manage that risk. We could use a backward looking lense to hopefully get a projection of what future performance or risk-adjusted returns might be. But, people cannot make informed decisions because they cannot truly know past risk, present risk, and more importantly future risk. As the economy changes and as individual assets within a portfolio change, daily, one must have a means of contemplating different asset allocations based on reality and make necessary adjustments to maximiz...

The American Recovery and Reinvestment Act 2009 has been passed as of Friday, February 13, 2009 ( ARRA 2009 ). It contains numerous investments (i.e.,government spending) in infrastructure, science, healthcare, education, energy, and protecting the "vulnerable". How will this affect consumerism? Sustainability? Green initiatives? Where will people demand their money be invested? Which industries will be supported by the act and which will slide? How will this impact the way money managers make decisions, rebalance portfolios, establish new strategies? What are the best mutual funds to invest in for 2009? Will it be large cap or small cap, international or domestic, growth or value, aggressive or conservative, or emerging markets?

Making money today is not easy, and managing money successfully is even harder. With the global financial and economic crisis in full swing chief investment officers of mutal fund families, mutual fund managers, and their analysts must navigate an incredibly stormy sea. It is global and it is pervasive and is affecting every asset class. New regulations, reporting requirements, ethics, moral hazard and other non-core activities weigh on the ultimate time and focus available for optimizing mutual fund portfolios. Everyone is concerned with risk, volatility, diversification and the performance of their money relative to other potential investment choices. Mutual fund managers must retain existing clients, attract new clients, and avoid the "run-on" issues of mass redemptions that severely cripple the NAV of their fund(s). How to rebalance? What equities to buy? Which ones to sell? When? Which add to returns while also reducing risk? These questions and other problems can be ame...

EARN MORE! RISK LESS! Diversification weighting, is a product of diversification optimization (of a portfolio). Allocation weights can be determined by the extent to which an asset adds uniqueness to a portfolio. Some studies show that using diversification weighting, rather than risk-based weighting, or capitalization weighting, could improve relative performance while decreasing portfolio volatility.

Harry Markowitz is the 1990 Nobel Laureat in Economics & creator of the 1950's era portfolio theory on the Efficient Frontier. Harry invented modern portfolio theory. In these uncertain of economic and financial times, you must use every possible advantage to saving your 401K, IRA, Mutual Funds and Investment portfolios. We believe a combination of Efficient Frontier and diversification analysis, coupled with risk mitigation strategies and an eye on the psychology of the market and economic conditions, can lead to improved investment performance.

Welcome to Mutal Fund Optimizer! We've created this informative blog to help improve investment intelligence and management of money, to help you better design portfolios to reduce risk, increase overall diversification, improve returns and save time and money. Check back often for news, tips and success stories. Thank you! From your Mutual Fund Optimizer team!