Bythe Lyne was in his fifties. He was a sales executive with a well known pharmaceutical firm. He had a portfolio of mutual funds that he had put together himself. You name it, he owned it. Country Funds. Emerging Markets. New Europe. New Economy. Smokestack Industry. Government Bond. High Yield. Conservative. Speculative.
Remains from every investment craze and theme for the last twenty years. The latest hot funds. The living dead funds that someone had forgotten to drive a wooden stake through or tell the trustee that the manager had been struck with the Bay Street Sleeping Sickness years before.
It took me a few minutes to gain my bearings as I sorted through the entrails of the portfolio statements.
"What do you think", Bythe said expectantly.
"I put it together over the years, mostly on my own."
I didn't know quite what to say. It was like trying not to gag on the turpentine taste of a homemade wine as the host gushed, waiting for your reaction.
"I've really never seen anything like this before", I said faintly.
There had to be fifty funds, I thought to myself.
"It must have been quite a task to assemble it" , I ventured.
"It's big enough that I think I can use some professional advice", said Bythe.
Understatement of the century, I thought. "I agree", I said.
That's where I came in, Sue Smart....... Chartered Financial Investigator |
The case was clearly out of my league. I didn't have the computer firepower to make sense of this bizarre and immense collection of financial flotsam. The arcane knowledge necessary to assess these apparitions from the mutual fund twilight zone meant there was only one person who could help me.
I'd have to make the trek to the Temple of Quantitative. It had been a while since I'd seen Lori Analytic. We'd worked together for years on the bond desk of Sharp and Shooter.
Where I liked the cut and thrust of bond trading and dealing with my clients, Lori sat off in a corner, mesmerized by her computer screen. As technology took over Bay Street, Lori's professional stature had grown immensely, far out of proportion to her slight physical appearance.
One day she shut down her workstation (the fastest money could buy) and gave the boss her resignation letter. She had made so much money on her own trading account, she was leaving the Street to manager her own portfolio. We kept in touch, and she occasionally did me favours by analyzing things that were way out of my league.
"I might be able to help you", I said to Bythe.
"I'll have to have a financial analyst look things over and see what your returns have been. It will take a while to input the historical data and do the analysis."
Bythe was still proud of his precocious portfolio child. "I think it's been good. I have a lot more than when I started." |
Lori's lair was in an old church. She had replaced the pipe organ with a multi-screen workstation that ran on the fastest processors that money could buy. She claimed that the moist silence of the old sanctuary helped her insights from the whirling kaleidescope of graphs, charts and tables that surrounded her.
She didn't even look up when we entered. She new that we were coming and perhaps she sensed the slight tightening of molecules that accompanied our entrance.
"It's in the first pew", she said. "I finished the work yesterday."
Still not looking up, she motioned for us to take a place in the front pew. There we found a stack of computer printouts. "The summary is on the first page. Sit down before you read it!"
It was incredible. The total return from the portfolio had been less than TBills over the last ten years. The overall equity return was less than any of the major stock indexes. The bond return was barely positive. I had to break it to him gently, but Lori beat me to it.
"You've got yourself quite a bundle of risk and return", Lori said.
"I know", Bythe said proudly. "I go to a lot of these financial planning seminars to stay in touch with what's going on in the markets".
"Let me guess", she said. "You were at the "Opportunities In Emerging Markets" seminar put on by the ForkOver Group in 1993?"
"That's how I got into the Banger Bangkok Fund", he said.
"Ever consider doing a bit of your own reading and research", she inquired?
"Prefer to hear from the experts", said Bythe.
"Your portfolio has lower return and higher risk profile than anything that I have ever seen", said Lori bluntly.
"I think its time for you to learn a little something about investing," she continued, "before you manage to make this portfolio disappear into the financial netherworld from whence it came."
Bythe was thunderstruck. Disoriented in his shock, he sat down slowly.
"Wh....What do you mean", he said hesitantly. |
"You've managed to get less with more", said Lori. "The funds you've chosen seem to have the unique characteristic of detracting from the overall portfolio performance."
"Take your investment in the Banger Bangkok Fund, for example", she continued.
"I bought that fund in 1993 because I thought that interest rates and inflation would go up and that would be bad for bonds", explained Bythe.
"Contrary to popular wisdom", lectured Lori, "stocks and bonds are "highly correlated" or move very similarly to each other."
"When interest rates increase, stocks and bonds generally move in the same direction. Your choice of a highly speculative small foreign market made things even worse."
"How could that be", inquired Bythe,"why would stocks in Thailand reflect the interest rate changes in the U.S."
"The assumptions used in existing studies of the historical benefits of foreign investing are open to question. There's a lot of evidence that stock markets all around the world are becoming more and more correlated. It could be because of increasing world trade and financial flows. Even the U.S. cannot "go it alone" any more."
" In 1993, the financial markets had been used to their steady fix of loose money. Big Al Greenspan at the Federal Reserve had been flooding the markets with cash to save the banking system from their incredibly stupid real estate loans. He couldn't keep this stimulation since it would inevitably result in very high levels of inflation. In the meantime, however, all this money caused a financial market boom in the U.S. which spilled over into foreign stocks."
"At the height of the foreign investment boom, a large U.S. index fund had dropped $1 billion U.S. into the small Thai market in a few hours of trading. They had to stay invested so they really didn't care about valuations. The Thai market shot up and this was about the time that you bought in late 1993."
"When Alan Greenspan and the Brain Trust of the Federal Reserve tightened monetary policy in early 1994, the stuff hit the fan. Unfortunately, when he tightened, the U.S. investors who had been dumping their boodles of excess cash into these tiny investment backwaters like Thailand got scared. Mexico was in the tank and the emerging markets were "submerging".
"Then credit contracted and "illiquidity" resulted. This means that nobody wants to buy anything without an immediate payoff. Where they couldn't see anything wrong with Thailand in 1993, by June of 1994 they had thrown in the towel and were desparate to sell. Pop went the market".
"Your safe haven from bonds actually fell far more than the bonds you were holding!" |
"Where you went wrong", added Lori, "was putting anything into the portfolio that came your way".
"It didn't help that you attended every seminar going".
"A proper portfolio structure is a thing of beauty. There has to be an overall philosophy to the portfolio and a reason behind its every part. It is profit waiting to happen."said Lori, her eyes flashing with energy and her face set with conviction.
"It's like a wardrobe. If you listened to every salesperson you happened upon or bought whatever caught your interest, you'd have the fashion equivalent of your portfolio. A complete mismatch of clothes that cost a lot but looked like heck!" |
"In other cases, you diluted the investment manager skill in the portfolio. You would have been better off in index funds which mimic the overall market and don't try to pick stocks."
"Look at your equity return. Your portfolio had a 5% return compared to double digits for the TSE, S&P and the EAFE. For the risks you took you received a much lower return than should have been the case."
Lori was not leaving Bythe many delusions of financial competency.
"Think of your purchases of the Smokestack Industrial Recovery Fund and the New Improved Economy Fund. Both of these funds have capable managers compared to some of the other "Fund Manglers" whose funds you hold. But their mandates are quite limited as these are "sector" or "theme" funds. The managers are restricted to specific types of companies in certain industries. The Smokestack Fund is looking for old and tired companies which are being revitalized. The New Improved Fund is looking for up and coming "new economy" technology stocks."
"The managers buy the best companies they can find with these characteristics but are very constrained in their selection. Neither has the ability to buy normal companies in reasonable industries. As has been the case with most theme or sector funds, once the theme or sector is out of "investment fashion", their results stink. Good managers only stink a little less. As Warren Buffet says, "When a good manager meets a bad industry, it's the industry that keeps its reputation"."
"Stink" was a very heavy bad word for Lori! She went on to point out that the "core" funds that Bythe had purchased had underperformed substantially. She explained that Bythe ended up with good managers on sector funds with limited ability to outperform combined with terrible managers on the rest of his portfolio with tremendous scope to underperform.. The individual parts were bad enough, but the sum of the parts combined into a portfolio that made things even worse.
"You would have been better off in index funds than the way you've applied the manager skills",said Lori in a scolding voice
It looked like our time was up. I quickly thanked Lori and we made our way out of the Temple of Analytic.
"What now?" asked a chastened and deflated Bythe Lyne.
"You can't have a portfolio without a overall philosophy and strategy", I said, quoting Lori.
"We need to see Fiona Baysus, the financial planner and Bubba Swami, the asset mix guru. I'll make the arrangements and call you tomorrow".
As we walked back into the concrete canyons of Bay Street, I looked over at Bythe. He seemed somehow smaller, both in stature and spirit. We'd taken something from him, and now it was time to get it back.
That's where I came in, Sue Smart..... Chartered Financial Investigator. |
