Author: bbatchelor

Article Link: http://www.ashmoregroup.com/insights/research/structural-growth-story-em-overtakes-sp-500-tech

Summary

• Fernando Assad, Jan Dehn and Chris Mader of Ashmore examine the make-up of the MSCI Emerging Markets Index (“MSCI EM Index”), how the composition of the index has changed over the past decade and the potential implications from those changes.
• Many individuals still view emerging markets as a commodity or cyclical growth story. However, structural growth drivers in technology, consumer, telecoms and health care now account for over 50% of the MSCI EM Index, compared to cyclical industries, which only make up roughly 20% of the Index.
• Emerging market valuations (P/E ratio) trade in-line with their historical average and significantly below developed markets (as represented by the MSCI World Index). The authors contend that emerging markets should trade at a higher than historical average valuation because of better earnings visibility and long-term growth for structural growth companies (compared to cyclical companies).
• Technology is particularly important for the transition of emerging markets from a cyclical growth story to a structural growth story. Seven out of the ten largest companies in the MSCI EM Index are now technology companies, and in aggregate, technology is a greater percentage of the MSCI EM Index (23%) than technology is as a percentage of the S&P 500 Index (21%).

Our Take

• Ashmore is one of many asset managers whose materials we read on a regular basis. We view their work in emerging markets as particularly useful during our market and economic reviews.
• In addition to the positive factors noted in this paper, other positive characteristics of emerging markets include: many countries have significantly improved their underlying financial condition (especially compared to the late 1990’s), an emerging and increasingly wealthy middle class is aiding in the transition of many larger countries from export-driven to service-oriented and the asset class as a whole has a relatively more attractive growth and valuation profile (compared to many developed market countries).
• Emerging market equities (in aggregate) have performed relatively poorly (notably compared to the U.S. equity market) over the past 5+ years. However, weak recent performance is another factor that we view as a positive because we tend to gravitate towards areas/regions of the global equity market that have underperformed (we try to follow the mantra of buy low, sell high as opposed to buy high after great results and then sell low when disappointed).
• The combination of positive factors noted above and in Ashmore’s paper, along with a number of other factors, make emerging markets one of the areas of focus in our portfolios currently.
• More specifically, we have made an investment in an emerging market equity manager that we have a high-level of conviction in for the long-term. Based on our research, we believe this particular firm has a strong investment team, is led by a talented portfolio manager and places a heavy emphasis on “boots on the ground” research. We believe all of those factors are critically important to navigating investment opportunities in emerging markets.

(Click on image to enlarge)

Summary

• The chart shown above was shared by Richard Turnill and the BlackRock Investment Institute in BlackRock’s global weekly commentary.
• The chart displays year-to-date equity returns for a selection of major country/regions through the end of July. The orange circle represents the total return for each country/region. Total return is then broken out between dividends (blue shading), multiple expansion (purple shading), which is calculated as price change minus earnings growth, and earnings growth (green shading).
• BlackRock’s view is that earnings growth, which has been flat to negative so far in 2016, would need to improve in order to generate further equity market gains.
• They are cautious for the second half because they believe an improvement in revenues and earnings may already be reflected in market prices.
• BlackRock’s main takeaway is that investors need to be more selective with their investments at these levels.

Our Take

• BlackRock’s global weekly commentary is one of many market commentaries that we review on a regular basis. We like this chart because we believe it conveys a significant amount of information about the environment for equities in one picture.
• We believe the combination of positive equity market returns and anemic, or even negative, corporate earnings growth sets the stage for a potentially challenging period for equities over the remainder of 2016.
• We share BlackRock’s view that any further equity market gains without a subsequent improvement in underlying earnings growth will lead to heightened volatility.
• Historically, during periods of heightened volatility, investors have gravitated to companies that have displayed earnings stability and companies that pay dividends. Dividend growers are particularly favored.
• For a number of reasons, we are maintaining a relatively defensive approach in our portfolio construction, and U.S. large-cap dividend payers are among our favorite ideas.

Article Link: http://www.reuters.com/article/us-usa-banks-wealth-idUSKCN1090DA

Summary

• Large U.S. brokerages such as Morgan Stanley, Bank of America and Wells Fargo are using a combination of incentives and penalties to push their financial advisors to bring in more multi-millionaires and move away from clients that have less than $750,000 to invest.
• The shift away from clients with “only” a couple hundred thousand dollars to invest continues to accelerate due to concerns about margins and regulatory change.
• The story notes that clients with less than $100,000 at Morgan Stanley and less than $250,000 at Wells Fargo and Merrill Lynch are being referred to call centers and digital advice platforms as bonuses and commissions for brokers are being trimmed or eliminated at those levels.
• From a regulatory standpoint, advisors are getting ready for the phasing in of the Labor Department’s fiduciary rule, which requires advisors to act in clients’ best interest. The current standard just requires that they offer products that are suitable.

Our Take

• The industry shift away from clients with assets from $50,000 up to $1 million is one of the four critical trends we identified when we initially defined the business model for Entasis. We believe everyone should have access to investment advice.
• All of our portfolios, including our GenerationTech^TM portfolios, which are specifically designed for investors beginning to accumulate wealth, are accessible to clients with lower household asset balances.
• All of our founders are CFA charterholders. We adhere to the asset manager code of professional conduct and are fiduciaries. We do not need regulation for us to move in this direction. It is our duty to act in the best interest of our clients.
• If you are an individual that has never worked with a financial advisor, does not believe you have enough assets to work with a financial advisor or have been directed to a call center by an advisor, please reach out to us.

Article Link: http://blogs.barrons.com/focusonfunds/2016/06/07/ab-ceo-kraus-active-managers-should-impose-capacity-constraints-to-boost-performance/

Summary

• In a recent interview, the CEO of AllianceBernstein Holding, Peter Kraus, told Bloomberg that he believes the entire active management industry has grown too large and may need to shrink by one-third if active managers want to beat industry benchmarks.
• He comments that assets in actively-managed products grew significantly for an extended period of time without much restraint and the subsequent performance of active managers (relative to their benchmarks) largely disappointed.
• He attributes the poor subsequent performance to the actively-managed portion of the asset management industry being too large and the diversification of holdings as active managers see an increase in the amount of assets under management. He believes the combination of those two factors has led to a decrease in the ability of active managers to produce the good results that contributed to the growth in assets in the first place.
• Kraus believes that every active manager should place capacity constraints on themselves.

Our Take

• Although Kraus spoke in generalities about the active management industry that were admittedly guesses, we agree with his underlying point. At the individual portfolio level, extreme asset growth or “asset bloat” impairs the ability of an active manager to beat its benchmark.
• We have witnessed the negative impacts of “asset bloat” in a number of actively-managed products over our careers. Eventually “asset bloat” tends to force active managers to adjust how they manage their portfolio and the securities they select for the portfolio. This may include changes such as increasing the number of holdings, reducing the percentage of assets invested in their highest conviction ideas, extending the time frame to enter or exit a position or increasing the market-capitalization of companies they target for inclusion in the portfolio.
• In our experience, there isn’t a simple threshold where assets under management becomes too large. However, the amount of assets that an active manager can effectively manage without suffering from “asset bloat” can be understood through an analysis of their investment process, the market segment in which they invest and the underlying portfolio characteristics. For example, an equity manager with $10 billion in assets that focuses on large- and mega-cap equities would most likely be able to invest that level of assets with minimal impact on its intended portfolio structure.  However, if an equity manager with that same $10 billion in assets focused on small- and micro-cap stocks, it would have to significantly expand the number of equity holdings in its portfolio. Without an expansion in the number of holdings, it would be hard to establish meaningful positions in companies without greatly impacting liquidity, among a number of other factors.
• We have a strong belief that “asset bloat” can adversely impact future returns. As a result, it is one of many factors that we closely monitor for our recommended asset managers. If we determine that a manager has taken on too many assets to manage its portfolio effectively and as originally designed, we will recommend that the manager be sold.

Article Link: http://www.forbes.com/sites/wadepfau/2016/05/19/understanding-how-financial-advisors-are-compensated/#660841a67a8b

Summary

• Wade Pfau, a professor at the American College of Financial Services, provides a brief summary on the different classifications of advisors and how they are compensated.
• Job titles such as “financial advisor” or “financial planner” are not regulated. Anyone can use the terms without oversight of their qualifications, education, training or competency.
• Financial planners or advisors generally fall into one of three main types: registered investment advisor, stock broker or insurance agent.
• Brokers and insurance agents are generally treated as salespeople. They are required to use a “suitability” standard of care with their customers. This means that any recommended financial product must be “suitable” for the purchaser’s situation, but the recommendations do not necessarily need to serve the best interests of the purchaser.
• Investment advisors are the only ones required to serve as “fiduciaries,” which requires them to act in the best interest of their clients and disclose any material conflicts of interest to their clients. “Fee-only” advisors are paid directly and only by their clients. They do not receive any commissions or other financial incentive for getting their clients into any particular investments.

Our Take

• There is a need for much better transparency into how financial representatives are compensated for their services. In addition, there needs to be a much higher level of scrutiny placed on titles and the requirements necessary to use those titles.
• Many individual investors do not fully understand the fees they are being charged (directly or indirectly through commissions or kickbacks) by their financial planner or advisor.
• We believe financial planners or advisors should be required to act in their best interest of their clients and provide clients with a clear understanding of how (and how much) they are compensated for their services.
• We are a registered investment advisor. We act in the best interest of our clients and believe strongly in fee transparency. See how we are different. Contact us today. We will share our fees and the questions you should ask your advisor about their fees.

See chart below.

Summary

• The chart shown above was shared by John Mauldin in his June 4 weekly newsletter, Thoughts from the Frontline.
• The chart illustrates year-over-year, trailing 12-month earnings per share growth for companies in the S&P 500 (excluding the highest growth sector for the red line and excluding the lowest growth sector for the blue line).
• Prior to the last two recessions (recessionary periods shaded in grey) earnings followed a distinct pattern – initial earnings recovery after the previous recession, mid-cycle slowdown, brief period of increased earnings growth and an end-of-cycle turn in earnings before the pre-recession rundown in earnings growth.
• The overall point being made is that we may have already moved through the end-of-cycle turn in earnings and may be in the pre-recession rundown for earnings growth.

Our Take

• We consume and analyze a vast amount of information on a day-to-day basis. We chose this chart because we believe it illustrates the present corporate earnings environment relative to recessionary periods quite well. By itself, it does not create action for us, but we do incorporate the chart into the mosaic that drives our decision making.
• Our view is that aggregate corporate earnings growth for the S&P 500 has actually had indications of softness for a while. Over long periods, top line revenue growth is a necessary element for earnings growth. However, corporate revenue growth has been weak for some time. Near record profit margin levels and other non-organic “boosts” to earnings, such as corporate share buyback programs, have just been able to mask this fact.
• If weak top line revenue growth is paired with the possibility of a weaker-than-expected economic environment (i.e. GDP growth), second quarter earnings season may end up being weaker in aggregate than most market prognosticators are currently anticipating.
• What does this information mean to us? As long-term investors, we are cognizant that earnings, economic activity and even active investment manager relative performance, traverse through their own unique cycles. We are not market timers or traders. We don’t believe the odds of compounding wealth over the long-term are very high using that strategy. As Warren Buffet professed, “Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”
• How do we incorporate this information into decision making? First, we are taking a relatively defensive approach in our portfolio construction. Second, we are being selective about the entry points for our clients’ investments. Finally, we will be making incremental modifications (trims and adds) to client portfolios over short- to intermediate-term timeframes.

Article Link: http://finance.yahoo.com/news/170-000-investment-pros-are-about-to-take-wall-street-s-toughest-test-190327310.html?soc_src=mediacontentstory&soc_trk=ma

Summary

• Investment management professionals in 91 countries sat for one of three levels of the Chartered Financial Analyst (CFA) exam, which the author referenced as the “Mount Everest of Finance.”
• The Chartered Financial Analyst designation requires passing three levels of exams (the first level is offered twice per year, while the second and third levels are offered once per year). In addition to passing all three levels (each exam is six hours), candidates must meet career qualifications (four years or more in finance).
• Pass rates for each level of the exam typically ranges between 30%-50%. Recommended self-study time ranges from 250-300+ hours per level. Curriculum covers micro-/macroeconomics, ethics, equity analysis, fixed income analysis, financial statement analysis, quantitative analytics, portfolio management, option pricing/strategy, among others.
• Lisa Plaxco states that, “It is the global gold standard for competency and integrity through the investment management industry, both for professionals and their clients.”
• Ethics are heavily tested. CFA charterholders are required to adhere to a strict code of ethics, or risk having their charters revoked.

Our Take

• At Entasis Asset Management we remember the first weekend of June all too well. All three founders (Bob Batchelor, C.J. Batchelor and Mike Peters) are CFA charterholders.
• We are passionate about investing and have a high level of respect for the CFA Institute’s focus on ethics.
• One of our core beliefs is that everyone should have access to an experienced investment professional and high quality asset management. Our account minimums, fees and portfolios reflect this conviction.
• Your wealth wasn’t created overnight. You’ve worked hard. You’ve saved. Understand the experience and credentials of your financial advisor.

Article Link: http://vanguardadvisorsblog.com/2016/05/18/mind-fund-details-not-labels/

Summary

• Frank Kinniry, a principal in the Vanguard Investment Strategy Group, discusses why it is important to understand the details of an investment rather than simply painting an entire category with the same brush.
• The line between so-called active investments and so-called passive investments has blurred. Hundreds of ETFs and “smart beta” funds have come to market in recent years. While many ETFs are traditional market-capitalization weighted index funds, many (including so-called smart beta funds) are not.
• The author believes much of the above may be occurring in order to “cloak higher-cost actively managed offerings under the secularly trendy banner of indexing.”
• He believes low-cost actively-managed funds can outperform the average index fund. In turn, he believes that it can be better “by far” to invest in a low-cost active fund when compared to a high-cost index fund or ETF.
• In summary, he states that it is overly simplistic to say that “indexing outperforms active management,” or that index funds are “low-cost” or “broadly diversified.”

Our Take

• Investors (individual investors and financial representatives alike) need to do their homework. The search for a simple answer by applying generalities is commonly a fool’s errand.
• We completely agree that many ETF’s and smart beta products are misunderstood, and in turn, typically masquerade as low-cost passive investments.
• We also agree that a key criterion for all investments, active or passive, is the direct (expense ratio) and indirect cost (turnover/trading costs) of the strategy. The lower the cost of the strategy, the less ground the active manager has to “make up” relative to its target benchmark.
• We utilize actively-managed and passively-managed investment products in client portfolios at Entasis. Read more about Our Process to understand our use of each.