Mutual Fund Selection 1
By William Parmenter, editor Dimensional Fund Advisors (DFA) created one
of the first index funds in 1981. DFA created
Timothy Bock, founder of Summit
Portfolio Management, spoke on the topic of passively managed mutual funds designed to
capture the added returns from small and value
mutual fund selection on Nov. 3 at the Santa
stocks. DFA funds aim to keep expense ratios
Monica branch library, 2101 Ocean Park Blvd.
and transactions costs low. The funds are sold
Summit Portfolio Management, founded
only through investment advisors.
in 1984 by Bock, has six offices and is a fee-
The active management approach takes
only financial consulting firm that offers
the position that stock prices are often incorrect
comprehensive personal financial services.
and can be exploited via market timing or stock
Portfolio structure determines returns, is
picking. In contrast, the passive management
Bock’s thesis. Only four percent of returns are
attributable to stock picking and market timing,
factors that can actually reduce return. Table of Contents
Bock reviewed active versus passive Timothy Bock …Mutual Fund Selection ….p.1
investing, coming down on the side of passive Erick Glicksman…Structured Products…………...p. 2
investing, due to the efficient market hypothesis. Sharat Shroff .Investment in India p.3
Investors should use index funds,
approach takes the position that market
because capital markets are efficient.
mechanisms price securities correctly, guided by
Concentrated portfolios have higher risks and
the efficient market hypothesis.
costs. Superior returns are attributable to asset
Evidence on these strategies comes from
structure. Picking a manager or funds based on
examining the results of the average stock fund
track record does not help. Less than 10 percent
investor. During the same period that the
of the managers of mutual funds actually add
Standard and Poors 500 returned an average of
13.2 percent a year, the average stock fund
Between 1926 and 2006: stocks
investor earned 3.7 percent a year. Bad timing
produced a 6.8 percent higher return than
based on emotional reactions was largely
Treasury bills; value stocks produced a 3.1
responsibly for the poor results.
percent higher return than growth stocks; and
Star fund manager performance may be
small company stocks produced a 4.7 percent
suspect. For example, Bill Miller of Legg
higher return than large company stocks.
Mason outperformed the S&P 500 for fifteen
To get a superior return one’s portfolio
consecutive years. But he is a value manager, so
should be more heavily weighted with small cap
should have been evaluated against a value
and value stocks.
index. Against that index he was average. Most
of Miller’s success was due to an early pick of
Relying on fund ratings is another way exchange and such financial instruments as:
to lose money. A study of five rating services options, swaps and forwards.
showed a fund receiving wildly different ratings Structured products meet the objectives
by different services. No consistency has been of enhanced return, risk management, market
found in fund manager performance. Regarding access, tax and regulatory efficiency, and cost
Morningstars’ ratings, it has been found that 80 and time efficiency.
percent of money goes into five star funds. But, The promise of enhanced return with
that is a formula for losing money, as three star structured products makes them attractive as
funds were found to outperform five star funds you doe not have to time the market and they
by a four percent compounded rate. reduce risk.
Bock had a number of conclusions: Structured products bridge the gap
invest. Don’t speculate. Passive investing is between the individual and the institutional
better, due to lower costs, less risk and above investor. With structured products you can
average returns. Control risks through defer taxes and convert short-term capital gains
diversification of securities, and countries. into long-term capital gains.
Control your emotional influences—a huge
source of underperformance and loss. Measure
results against appropriate benchmarks. Get Los Angeles County Meeting Schedule
expert guidance if you are not an expert.
Bock distributed an information packet, Westside Computer Group – Don Gimpel, 310/276-9875
firstname.lastname@example.org Sat. Dec. 1, at 10:30 a.m.. Veterans of
containing eight articles on financial topics, Foreign Wars Memorial Bldg. Culver Blvd. & Overland Avenue,
such as how emotions influence investing Culver City, Topic The Retirement Withdrawal Issue (featuring six
outcomes, equilibrium-based investing, active
versus passive management, and strategies to Pasadena Group – Pasadena Library 285 E. Walnut Street,
Topic and date TBA
reduce taxes. These articles and many more are
available at Bock’s website, at: Mutual Fund Group – Gunter Hagen 310/457-7404,
email@example.com. 10:30 a.m. Sat, March 1, 2008. Topic:
www.summitportfolio.com. Smart Investing Strategies and Global Investing Trends. In the
community room of the Fairview Branch of the Santa Monica
Public Library, 2101 Ocean Park Blvd., Santa Monica. The
Improving Portfolio Efficiency Using meeting is free to the public
Structured Product Investments
Stock Selection Group—Norm Langhout, 310/391-6430,
By William Parmenter, editor firstname.lastname@example.org. Fourth Wednesday of the month at 7
p.m. Fairview Branch of Santa Monica Library, 2101 Ocean Park
Blvd., Santa Monica. Topic TBA
Erick Glicksman spoke on structured
financial products at the Skirball meeting of the San Fernando Valley Group – Mid Valley Library Community
Room, 16244 Nordhoff St. North Hills, Topic, TBA
AAII Los Angeles Chapter on Saturday,
November 17. Glicksman is Managing Director IBD Meet-Up/AAII CANSLIM Group – Santa Monica Library,
Fairview Branch, 2101 Ocean Park Blvd., Santa Monica
and head of product development for structured
products at UBS. Los Angeles Chapter Mtg.—No meeting in Dec. 2007. Up-coming
meeting dates through July for 2008: Jan. 12, Feb. 23, March 22,
Structured products are defined as an April 19, May 17,, June 28, and July 19.
emerging investment class; they are a means to
get access to liquid asset classes. Currently
structured products are more common in
Europe. Growth of structured products started in
Traditional investments include stocks, Europe in the early 1980s, but has lagged in
bonds and cash. Nontraditional investments development in the U.S.A. Structured product
include: hedge funds, commodities, foreign growth in the U.S.A. hit $1.8 B(illion) in 1998,
grew to$9.6 B in 2003; rose to $40.4 B in 2007,
and is projected to hit $100 B in the U.S.A. and most competitive level. Structured products is a
$200 B in Europe by the end of the year very robust area that is “growing like crazy.”
The majority of money invested in
structured products comes from individual Growing in a Slowing World,
investors. Investment Opportunities in India
Structured products can access: indexes, By William Parmenter, editor
individual equities, hedge funds, commodities,
interest rates, foreign exchange rates, baskets of India’s equity market and business
credits and baskets of equities. climate offer challenges to overseas investors,
The components of structured products but progress is being made, and the country has
fall into four risk categories, as follows: an enticing growth rate. Sharat Shroff, CFA,
1) Protection: in which 100 percent of portfolio manager for Matthews International
the investment is guaranteed at the end of Capital Management, LLC, spoke on investing
investment term. Example: an absolute return in India and the country context at a November
barrier note with a term of 18 months, and 100 17 talk to the Los Angeles Chapter of AAII at
percent principal protection, with the underlying the Skirball Center.
index being the S & P 500. Among the challenges to foreign
2) Optimization: in which the return on investors are ownership restrictions (a premium
the investment is range bound at the end of the is charged to foreign investors for such stocks as
investment term. Example: a yield optimization telecom, banks and defense), tax laws are
10 percent per annum note with contingent ambiguous, the rupee is not fully convertible,
protection with a range bound return and a one- and shorting of stocks is prohibited to
year term, issued by UBS. institutional investors.
3) Performance: uses a tactical strategy The difficulty in direct overseas
for flat or bullish markets, with the S &P investment in India led to the rise of a parallel
financial index as the underlying index. market, where participatory notes (offshore
Example: an autocallable optimization security, derivative instruments) were sold. They rose in
with contingent protection, with a one-year value from about $7 billion in 2004 to about $90
term, callable quarterly, issued by Lehman billion by late 2007, accounting for 8 percent of
Brothers. India’s total market capitalization.
4) .Leverage: the most risky as the In mid-October, the Securities and
investment would be in call or put options. Exchange Board of India announced measures
Example: performance securities with to substantially curtail the issuance of
contingent protection, with S&P 500 being the participatory notes, in hopes creating a more
underlying index, and the issuer being HSBC equitable market between domestic investors
USA Inc., with a term of five years. It trades and participatory note investors.
daily, giving a higher risk-adjusted return. India’s growth rate has picked up
Glicksman envisions structured products significantly. Between 1950 and 1980 it was3-4
as a component of your portfolio, along with percent; between 1980 and 2000, it was 5-6
equities, bonds, real estate and alternative asset percent; and between 2000 and 2005 it was 6-8
classes. percent. Growth has been stable within a band
In the question and answer session, of 4 to 8 percent for the last 10 years.
Glicksman pointed out that UBS is developing The government’s micromanagement of
financial products with a longer holding time to the economy and a stifling bureaucracy have
avoid tax hits. The three percent fee, an been sources of complaint, but the situation is
opportunity cost, is being squeezed down to the improving. Entrepreneurial activity is
increasing despite existing constraints: 11
procedures to start a new business; 35 days to This quarter, heavy industry and infrastructure
start a new business; 1,420 days to enforce a companies reported strong results, while
contract; and 10 years to close a business. companies in consumer goods and automotives
Transformation of the economic had compressed operating margins due to rising
landscape, particularly in big cities, reeling from costs.
population inflows, is under way. Average age The Bombay Sensitive Index (Sensex) of
in India is about 25 years. Capital markets need 30 stocks had a twelve month forward P/E of
to be deepened and broadened. Deregulation about 16 in 2007, and a growth rate of around
and privatization are opening up new markets in 20 percent. The growth band has been between
a country that is aiming at achieving a greater 15-21 percent since 2002. The index cannot be
balance between manufacturing and services. purchased.
Unequal wealth distribution (making for Foreign capital continues to flow into
political volatility), a dearth of public health India at a rapid pace, so far $17 billion this year,
resources, inadequate educational opportunities, double the amount in all 2006. Capital inflows
lack of infrastructure and a populations base of have led to a rapid appreciation of the rupee,
hundreds of millions of peasants subsisting on although the currency was stronger in 1980 than
less than $1 per day are all simultaneously today.
significant economic challenges and Shroff distributed informational packets
opportunities for growth. containing two in-house magazines from
India needs to broaden its base of Matthews International Capital Management,
growth, as the informal economy amounts to 60 and a quarterly report and prospectuses on the
percent of GDP, and employment growth has Matthews Asian funds. Matthews has nine
been stagnant over the last decade. Also, there Asian mutual funds, including four aggregate
has been a stall in the reform agenda with an funds, a technology fund, and four country
uncomfortable alliance between Congress and funds, including the India Fund.
center-left parties, with high decibel anti- The India fund (symbol MINDX) started
capitalist rhetoric coming from the communists. in Oct. 31, 2005, is an open-ended fund with
The social dilemma is how to create jobs for $1.1 billion in assets, and operating expenses of
those hundreds of millions surviving in grinding 1.41 percent. The fund is spread across various
poverty. sectors, the heaviest weighting being financials,
On the bright side, the much publicized industrials, consumer discretionary, information
software sector generates $45 billion a year, and technology and health care.
is growing at 30 percent a year. Yet it amounts The India fund’s benchmark is the
to less than one percent of employment and five Bombay Stock Exchange 100 index, which it
percent of GDP. India is a large regional has significantly underperformed. As of Oct.
supplier of pharmaceuticals, which amounts to 5 31, the fund had a one-year return of 50 percent,
percent of GDP, and is growing at 25 percent a compared to 69 percent for the benchmark.
year. Since the fund’s inception it returned 52
India is self-sufficient in agriculture, percent, compared to 71 percent for the
coal, cement and other commodities. But, 55 benchmark.
percent of oil is imported, and paying for More information on Matthews Asian
imported oil presents a formidable problem. funds can be obtained on the web at:
Bombay’s stock market was the first www.matthewsfunds.com .
stock exchange founded in Asia, but capital
markets are still largely undeveloped.
The Bombay Stock Exchange 100 Index
finished the month of October at record high.
Pro Forma Editor William Parmenter
Pro Forma Editor, Emeritus Orvis Adams
SIG GROUP CHAIRMEN
Asia Pacific Group Robert Hsu
IBD Meet-up/ AAII CANSLIM Norman Langhout
Mutual Fund Group Gunter Hagen
Pasadena Group Ivan Wong
Palm Springs Group Patti Gammino
San Fernando Valley Group Evan Press
Westside Computer Group Don Gimpel
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