Tortoise and Hare Portfolios

I have designed 2 new tracking portfolios and will be launching them this week. The stocks have been selected and I will start the tracking from the open of the market on Monday (the beginning of the quarter). The first portfolio is an aggressive growth "hare" portfolio and the second is a conservative growth "tortoise" portfolio. The management of the portfolios will mimic that of the Equity Select Portfolio:

1) The portfolios will have a long only, buy and hold mandate.
2) The portfolios will remain 100% invested in equities at all times.
3) The tortoise portfolio will have a maximum of 5 equity positions, the rabbit will have 10.
4) There will be no market cap limitations on the portfolios. Domestic and international equities can be utilized.
5) Starting with the first trading day of each quarter there will be a 10 trading day period in which changes can be made to the portfolio.
6) A strong emphasis will be placed on limiting portfolio turnover.
7) The portfolio will be tracked and performance reported on this site at least quarterly.

I expect to get the portfolios up by the end of the day.

Equity Select Portfolio, 27.4% YTD

The five stock Equity Select Portfolio (ESP) I track is up 27.4% after three quarters. The S&P returned 7.69% over the same span. I do not have any money directly invested in this portfolio. It is used solely as a research tool. You can see from the graph below that the ESP had a very difficult quarter. However because the ESP has a long-only, buy and hold mandate I did not change any of the positions in spite of a turbulent August.



Some of the key portfolio stats have fallen since a phenomenal first quarter performance, but the Sharpe ratio is still comfortably above 1 and the performance has been strong. Apple was again a top performer in the quarter, making up for weakness in the financial stocks during the ongoing credit market crisis:

The change I made at the close of the market on July 11th to switch from Sears Holdings (SHLD) to BHP Billiton (BHP) turned out to be a smart one in the short term. However, at first the change seemed to have backfired. Five weeks after the change BHP was down almost 20% and it looked like my decision to increase international exposure and increase exposure to basic materials was a bad move. But, over the last 5 weeks of the quarter BHP went on quite a run, ending up 18.92% since the change. Over that same period SHLD is off 17%. At the time of the change the other serious consideration for the spot to replace SHLD was CVS. Since the change CVS is up 9.69%. CVS has also been significantly less volatile than BHP or SHLD. While I would love to add CVS to the portfolio is is not a top 5 position at the current time. Below is the performance of SHLD, BHP, CVS and the S&P 500 since the change on July 12th:

This portfolio has done quite well through three quarters. I have two weeks from today to review the portfolio and make any changes. While I don't foresee any changes to the equity holdings I might pursue a portfolio rebalancing to take advantage of the loss position on Sears Holdings. If you have suggestions for an addition to the portfolio please let me know.

Why Currency Exposure Matters

Most investors don't think about currency when they are investing. I think that is a mistake. Today Bespoke provided a perfect example of why currency matters . . . .

If you own all domestic stocks and bonds and the dollar drops consistently against a basket of other currencies your real currency weighted return is actually much lower. Ignoring currencies is not a smart decision.

Yale's Endowment Turns In Another Stellar Year

Yale's David Swensen is a pioneer in multi-asset class investing. I've taken to reading Yale's annual reports to dissect Swensen's asset allocation and methodology. Something tells me I'm not the only one doing this. When Swensen inherited Yale's $1.5 billion endowment in 1985 their asset allocation was roughly two thirds stock and one third bonds. In the graph below, the first thing you will notice is how dramatically Yale's portfolio has changed over the years. Swensen has invested heavily in hedge funds, private equity, real estate, commodities and other alternatives. Today he has only 3.8% of Yale's portfolio in fixed income and just 11.8% in domestic stocks. I expect both of those figures to continue to trend lower. You can see in the graph below that Swensen has gotten progressively lighter on domestic equities over the past 10 years and recently he has gotten rid of most of his fixed income exposure:
Yale's $22.5 billion endowment is the second largest in the country behind Harvard's $34.9 billion endowment. But, Yale has been the top performing large (>$1billion) endowment over the last 22 years. This past year was no different as Harvard turned in a very respectable 22% return under Mohamed El-Erian and Yale put in a best of class 28% return:It is absolutely amazing that David Swensen is still at Yale and not running his own fund. If their was ever a guy who could raise $5 billion on a whim and immediately cash in it is David. There must be something else that drives him to stay in the ivory tower . . . .

Hat Tip: WSJ

Enjoying 6 Months Sans Rent

I don't know why they are trying so hard . . . they should just kick back and enjoy the house mortgage free until the bank comes and kicks them out. I just don't envy that insulting tax bill that comes saying that the loss you took on that house is actually income . . .
Hat Tip: Jim the Realtor (I can finally see your pictures!)

Hedge Fund Fraud: Our Tenth Year!

The SEC posted a press release today that almost made me fall off my chair laughing (until I started feeling bad for the investors who fell into the trap). Allegedly a San Francisco based "Hedge Fund Manager" raised $10 million of seed capital for his startup fund in 1997. For ten years he falsified performance statements and bragged about his performance to his investors. In reality however he actually just used the fund as his personal bank account. He bought real estate, cars and European shopping sprees for his ex-wife (unlike his investors it sounds like she got out just in time) . The hedge fund was called the Fahey fund. You can check out his "low budget" website here. The guy actually has a form on his site to set up a self-directed IRA in order to invest in his fund. Now, it would seem as if a mere 5 minutes of due diligence would expose this guy, yet he lasted for a full 10 years (see the "Out Tenth Year!" celebration above), so he must have been good. You can read the full press release below:

SEC Brings Fraud Charges Against San Francisco Hedge Fund Manager

FOR IMMEDIATE RELEASE
2007-203

Washington, D.C., Sept. 26, 2007 - The Securities and Exchange Commission today charged a San Francisco hedge fund manager with defrauding investors by dramatically overstating the fund's profitability and misusing fund assets. The Commission alleges that Alexander James Trabulse sent account statements to investors in his Fahey Fund that inflated the fund's returns by as much as 200 percent, while using investor money to purchase cars and finance shopping sprees for his family members.

"Trabulse betrayed the trust investors placed in him by fabricating performance figures and treating the hedge fund as if it were his own personal bank account," said Linda Chatman Thomsen, Director of the SEC's Division of Enforcement. "The Commission is determined to hold hedge fund managers accountable when they deceive investors."

Helane L. Morrison, Director of the SEC's San Francisco Regional Office, added, "Trabulse encouraged his existing investors to serve as references for new investors. As a result, his false account statements not only lulled existing investors into believing their investments were hugely profitably, but lured new investors into the fraud."

According to the Commission's complaint, filed today in federal district court in San Francisco, Trabulse founded the Fahey Fund in 1997 and raised about $10 million from approximately 100 investors. He told investors the fund invested in financial instruments like stocks, derivatives, and foreign currency. The complaint alleges that Trabulse lured investors by touting the fund's spectacular performance, when in reality the statements he provided to investors bore no relation to the fund's actual performance.

The Commission also alleges Trabulse misused fund assets to pay for a wide variety of personal expenses, using the fund's bank account to pay for cars, a home theater system, and his ex-wife's overseas shopping allowance. He even gave one relative free reign to use the fund's bank accounts for personal use, according to the Commission.

The Commission's complaint alleges Trabulse violated the antifraud and registration provisions of the federal securities laws, and seeks disgorgement, penalties, and other relief. The Commission also has named as relief defendants several entities associated with Trabulse that received assets through Trabulse's fraud.

Hat Tip: Footnoted.org

Biggest Home Price Drop Since 1991

Home price declines are accelerating after August's credit crunch put additional pressure on underwater borrowers. According to the S&P/Case Shiller Indices home prices for their 10 city index are off 4.5% year over year which is the largest fall in the index in 16 years. The Case Shiller Indices were pioneered by Karl Case and Yale economist Robert Shiller, who is perhaps best known for his best-selling book Irrational Exuberance, in which he examined asset bubbles throughout history. Shiller's second edition of Irrational Exuberance argued that the U.S. real estate market was a bubble in 2005.

I personally think that Shiller has made a very sound argument that real long term home price appreciation has been quite small (roughly 1%/year over the past 115 years). The graph he produced shows a significant break from trend in home prices in the latter half of the 1990's. It became increasingly difficult to explain the break from trend, and now it appears that home prices are moderating. How far they will fall is anybody's guess. Moody's thinks it will be about 11%, some aggressive economists are predicting a 25% total decline in prices. I bet if you asked Shiller he would be afraid to tell you for fear that you wouldn't take him seriously.


Before I start discussing the recent declines I think it is important to touch on why I rely on the Case Shiller numbers instead of median prices. I prefer the S&P/Case Shiller methodology because it tracks the price path of individual representative homes in a given geographical area by using "matched price pairs." This methodology enables the index to avoid many of the issues with using median based pricing models. For example in the current downturn home price declines were obscured in part by slower sales on the lower end of the spectrum while higher end homes continued selling at a brisk pace. So, although home prices were largely falling the lack of sales on the low end led to a drifting up of the median price, masking home prices declines. Needless to say I am not a big fan of median pricing. This is especially true because median prices are in large part reported by the National Association of Realtors, an industry group I don't see eye to eye with. The other index that is worth looking at is the OFHEO, which is calculated using a similar methodology to Case Shiller.

Here's the S&P Press Release:

New York, September 25, 2007 – Data through July released today by Standard & Poor’s for its S&P/Case-Shiller® Home Price Indices, the leading measure of U.S. home prices, shows a continuation of negative annual returns in the 10-City Composite and the 20-City Composite, as well as 15 of the 20 metro area indices. Both composite indices have registered negative annual growth rates since the beginning of the year. In addition, both indices rate of decline has become larger in each of the seven months from January through July.

Prices in my home town of San Diego are off 7.8% YOY, the third worst of any city of the 20 cities that S&P tracks. The worst home price depreciation occurred in Detroit, which is off 9.7% YOY. The best home price appreciation was in Seattle, which is up 6.9% YOY. The 20 city composite index is down 3.9% YOY.

The Economics of Buying a Hybrid

If you are considering buying a hybrid you must first go check out TheIssue.com's analysis of the economics of buying a hybrid:

Hybrid cars are often considered the perfect match for the thrifty and environmentally conscience consumer. They save gas money, reduce pollutive emissions and ease demands on strained energy sources. While these benefits are almost certainly true, the cost-benefit equation is more complicated. Many would-be buyers find that the technology premium outweighs gas savings, and others point to environmental drawbacks like battery manufacturing.

Read on at TheIssue.com.