Thursday, May 29, 2008

Investing IV

I ran into a person recently who was relentless with their "index investing" mantra. And let me repeat, index investing makes a lot of sense for those who do not consider themselves very sophisticated or those who do not want to bother with management. Your essential claim is "the general market's expectations are more accurate than my own would be." And that makes sense for some people.

Now I want to turn to portfolio strategy for a moment, then I'll turn to vehicles and useful tools. The strategy I laid out in the last post (mixing actively managed funds and passively managed funds) is called the Core/Satellite strategy. In this strategy you gain broad exposure by investing in index mutual funds for the majority, or core, of your portfolio. The core is usually made up of a Large-Cap U.S. index fund, a Mid-Cap U.S. index fund, an International Index fund, a Real Estate index fund, and a Bond Index fund. This should comprise about 70-85% of your portfolio. The rest is meant to be deployed a little more strategically in opportunistic or alternative investments. So what are some of those?

Emerging Economies: Tons of variety here. If you want Indian nano-tech, you can find a fund in that space. This could be a country or industry specific investment. Other up-and-coming countries to evaluate would be Vietnam, Ukraine, Scandinavia, Poland, Brazil, Mexico, and South Africa. You are looking for political stability, strong GDP growth (above 4%), currency stability (if the currency is pegged to the dollar, that is generally not a good sign. The country should have a market determined exchange rate), and a favorable business environment that enforces rules.

Infrastructure: Infrastructure is another interesting space. Infrastructure includes roads, bridges, utilities, airports, etc. The asset class will not give you as much up-side potential as investing in equity mutual funds because they are more conservative. But, they could dependably offer a return in the high single or low double-digits. Also, most infrastructure is tied to inflation (i.e. tolls, utilities, etc) so you can protect against potential rampant inflation. Inflation may not be your concern in the U.S. but it might be in Latin America. Infrastructure could give you meaningful exposure without the risk of losing big in the event of a massive peso devaluation.

Commodities: These include precious metals, timber, crops, and oil. Obviously these have been attractive areas over the last few years. And they are the only asset class that is negatively correlated with the S & P 500, meaning they do well with the stock market performs poorly (the opposite is also true). Commodity prices are tied to inflation, when inflation increases, so do commodity prices. There is also a strong demand component. Global demand is what really fuels commodity prices. As you might guess, developing countries like Brazil, India, Russia, and China are consuming more and pushing the global demand for commodities through the roof.

Clean Tech: Here's an area that has received substantial attention over the last couple years. You can reasonably assume that major dollars will continue to flow to cleantech. This is a very broad area that covers solar power, wind power, alternative fuels, green infrastructure, etc. However, the asset class is very dependent on political mandates.

You can make investments into any of these arenas through mutual funds. You could also use ETF's. ETF stands for Electronically Traded Fund. Their composition is similar to a mutual fund (pool of money spread across various holdings), but they trade like a stock. To this point, I haven't mentioned trading. Whenever you trade a Mutual Fund you have to wait until the close of business to get your price. So, if I decide at 9:00am to sell my mutual fund, I can enter (assuming you use an online account) the trade but will not know what the underlying price of my fund will be until the close of business. Many people don't like that. With an ETF, you can trade immediately and know exactly what the price is. They are also cheaper than Mutual Funds, with lower expense ratios. The downside? Everytime you buy or sell, you pay a commission (which is minimal). If you are one to actively trade, they probably don't make sense. But if you are the type to buy and hold, then they are a great option.

Some websites are very helpful in building a portfolio. I've mentioned Morningstar, but there are others that are equally as helpful. Here's a list.

Yahoo Finance ( Portfolio tracking and market news
Motley Fool ( Advice
Bogle Heads ( People will critique your portfolio (beware, not are all qualified)
AAII ( American Association of Individual Investors. Great site, excellent resource. You can become a member for a very small fee (I think around 20 dollars) and they will introduce you to various portfolio strategies with performance. They also put out a nice publication and list top finance websites.

There are thousands of others, but the ones above are a little off the beaten path. In my next post, I'll tie up personal portfolio construction.

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