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Active Versus Passive Investment Strategy…Which is Best?

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By Mack Bekeza

Investors have been debating if it is better to have an active investment strategy or a passive one. On one side, investors claim that being active will allow them to capture the best investment opportunities and optimally manage risk. On the other side, investors claim that going passive will help them secure long-term returns while being able to diversify unnecessary risk. Is one side more accurate than the other? We can’t really say. However, we can say that there is one thing that plays a very significant role in this argument…fees!

How do fees affect investment returns? First, let’s review the three common places fees show up in our investments, particularly mutual funds: Sales-loads, management fees, and 12b-1 fees.

How do these fees affect overall investment performance? Recently, Standard and Poor’s conducted research on how fees affect active managers’ performance against their benchmarks and came out with some noteworthy results. For U.S equity funds,       70% – 92% of active funds in their respective categories underperformed their benchmarks[1] over five years, net of fees. In other words, the vast majority of actively managed U.S equity funds underperformed U.S equity index funds over the course of five years[2] after fees. However, only 30-65% of actively managed fixed-income funds in their categories (excluding long term government, high-yield, and emerging markets) have underperformed their benchmarks after fees. International equity funds have also experienced a smaller percentage of their funds underperforming after fees, ranging from 47%-79% in their categories.

So, what does this mean for those who invest in mutual funds? Although there could be a case made that going active in fixed-income has benefited investors, being passive (investing in market index funds) has been more rewarding to investors over the course of five years. Will this trend continue? We don’t know. However, we do know this: index funds have posted better long-term performance than active funds due to having fewer fees and by mimicking the market, rather than trying to beat it.

© Castle Rock Investment Company. All rights reserved. Please share your insights with us at mack@castlerockinvesting.com or via phone at 303-719-7523

[1] Note that the benchmarks in this study are indexes made by Standard and Poor’s, this writing only mentions returns after fees with retail mutual funds, not institutional mutual funds. Here is the study that we are referencing: http://us.spindices.com/documents/research/research-spiva-institutional-scorecard-how-much-do-fees-affect-the-active-versus-passive-debate.pdf?utm_medium=Email&utm_source=Eloqua

[2] Index funds are not the benchmarks themselves, rather they attempt to mimic them.

Water Cooler Wisdom: Second Quarter 2016

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By Mack Bekeza

Is the U.S the only place for long term returns?

Although the United States has experienced one of the best bull markets in terms of duration and returns, investors have been wondering what is next. This past year has not been as invigorating as the prior few years and, on top of that, economists are predicting U.S GDP growth to be at around 1.5% for the next few years. You may have also been hearing from either presidential debates or that “one guy” at the bar that everything is going down the tubes and that we have seen our best days. Are they right? The answer is, we do not know.

What we do know is this, even though the U.S is still considered the safest place for investors, that doesn’t necessarily mean we should only be invested in American securities. Did you know that the rest of world accounts for 95.5% of the human population, nearly 75% of the global GDP, and nearly 60% of the total stock market? On top of that, international securities are not perfectly correlated with the U.S markets so they can be used as a very effective diversification tool for people of all age groups and time horizons. So why don’t people invest outside of the U.S?

There a couple of reasons:

  1. Many people have a bias towards their home country
  2. Many people fear that investing internationally is unbearably risky

To respond to those two reasons, there is nothing necessarily bad about being biased toward your home team but there is also nothing wrong with tapping into other developed countries and even emerging markets such as China and India to name a couple. And for people fearing that going international is overly risky, that is not necessarily true. Although volatility is more prevalent, that does not mean that international securities are a sure way to lose money. In fact, it is the volatility that will allow more buying opportunities which in turn can boost returns for people like you and I.

So despite what happened this past quarter (Brexit, continued negative interest rates in Europe, along with current slow global growth), we should still expand our horizons into the international markets and tap into the opportunities they present.

Attached are a few slides about global markets for the past quarter.

©2016 Castle Rock Investment Company. All rights reserved. Please share your insights and comments with us at Mack@CastleRockInvesting.com.

Brexit: What’s the Big Deal and What You Should Know About it?

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By Mack Bekeza

As you may or may not know, The United Kingdom (”UK”) has voted to leave the European Union (“EU”). For decades, the UK has argued left and right whether or not their relationship with the EU is worthwhile. Think of this as an old couple who have been constantly bickering at each other and all of a sudden one of them throws water at the other person telling them to take a hike but then asks them if they can still be friends. In other words, the UK will no longer be a part of the EU but still needs them as a crucial trading partner.

In the midst of this, global markets have experienced some wacky volatility. As of June 27th 12 P.M EST, the British Pound was trading nearly 16% less than it did on the previous Friday morning. The S&P 500 has also experienced a 4% decline as of June 27th 12 P.M EST compared to the previous Friday morning, not to mention that the next jobs report is expected to be dismal, causing further volatility. On the other hand, Gold has shot up and Treasury yields dropped as investors flee to safety, this is usually expected when currencies drop drastically like this.

So what does this all mean to us as investors? Is this the beginning of a global recession? The answer is that we cannot make these assumptions just yet. However, it is crucial to remind ourselves that we should invest for the long term and keep in mind our retirement goals. It is also important to keep in mind that this will be a great opportunity for those who Dollar-Cost Average to take advantage of the lower prices as we should expect a rebound to happen eventually. And always remember the famous quote from the British Government during WW2, “Keep Calm and Carry on!”

© 2016 Castle Rock Investment Company. All Rights Reserved. Please share your insights and comments with us at mack@castlerockinvesting.com or call us at 303-719-7523.

Water Cooler Wisdom: Fourth Quarter 2015

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“What, if anything, can the rest of the world do to mitigate the volatile China impact?” – Anonymous client

Great question…and unfortunately, I don’t know the answer. Free trade is a basic American principle than underpins our capitalist system (my editor removed “mostly capitalist”). Of course, we all know that free trade isn’t truly “free” and America still operates from an unfair position with China. This is not new in 2015 but what’s changed over time is how quickly information is disseminated to “investors,” (human or not) and the speed at which our intermediaries can transfer funds.

Watching China move from a manufacturing to a service economy is like watching an awkward teen move into adulthood. You can’t hasten the pace, or make them mature overnight, since some things just take time. China implemented market circuit breakers on the first day of trading in 2016 that were tested that same day. Trading was suspended for 15 minutes when the market (CSI300 Index) dropped 5% and halted the rest of the day after the market dropped 7%. The circuit breaker was deactivated later that week after halting trading twice and exacerbating the market sell-offs it was designed to limit.

Back at home, the U.S. economic numbers generally look sound but there’s nothing to get excited about. We are missing that one glaring opportunity to spur inflation and, in turn, wage growth. Long-term GDP growth of 1.5% is a yawner, labor force participation is down to 62.5%, and we know the graduating class of 2015 is the most indebted class ever.  In other words, they’ve already consumed a larger part of their future income than previous graduates. Talk about a drag…on the economy.

It is ironic but a drop in the value of the U.S. dollar, an increase in interest rates, and a drop in the supply of oil actually sounds good right now (see “Oil Markets”). It makes me long for the days of 13% interest rates and long lines at the gas pump when you could only fill up on odd or even days (depending on the last number on your license plate).

But then again…stagflation is depressing. I’d take today’s economy over the 1970’s any day. Economists disagree on whether there will be three or four Federal Reserve rate hikes in 2016 (see “The Fed and Interest Rates”) and in spite of a 0% return in money markets, we have almost $12 Trillion in cash (notice the capital “T,” see “Cash Accounts”).

Conclusion
As usual, we recommend a balanced portfolio with a risk profile suitable for each investor’s tolerance and goals. 2015 seemed to play out the new normal of volatility, but we should continue to invest wisely, steadily and with discipline. Volatility is here to stay.

Water Cooler Wisdom: Third Quarter 2015

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During last quarter’s review meeting, I promised a snarky review this quarter, but “good grief” as Charlie Brown would say. The “Grexit” story from July feels insignificant at this point. Greece is now negotiating the “transfer” of over 50,000 migrants and refugees. In fact, the International Organization for Migration reported that more than 35,000 migrants and refugees arrived in Greece during the first week of October alone for a total of almost 435,000 since January.

Perspective: It’s hard to get upset about a reduction in your pension check when you are surrounded by refugees who were forced to flee their homes by armed conflict. A tough year is all relative.

The vast majority of Syrian refugees have fled to neighboring countries, including Turkey (about 1.9 million), Lebanon (about 1.1 million), and Jordan (about 630 thousand). The impact of the global migrant crisis and the response by government leaders is a bigger issue than can be addressed here. Germany is expecting more than 800,000 people to claim asylum this year, which may provide a little relief with their aging demographic issues. Perhaps a silver lining?

But let’s move on to the stories that impacted the bottom line.

China Slowdown

At the beginning of August, we became aware of the ongoing slowdown in China when July’s Purchasing Managers’ Index (“PMI”) fell to 47.8. Just eight days later, the Chinese government unexpectedly devalued the Yuan by 2.0%, surprising markets and sending stock prices tumbling around the world and making us all believers that something was awry in China. When the August PMI came in at 47.3, it reinforced concerns of a global slowdown. That weighed even further on global commodities and markets prompting the Fed to leave rates unchanged yet again. It appears that China is struggling to transition from an investment-driven economy to a consumer one and they may have mistakenly used one of their tools as a sledgehammer.

Commodities

Remember the days when it seemed as if China was going to either consume or contractually gobble up most of the world’s natural resources? It reminded me of when my father would complain over dinner about the Japanese buying up Manhattan real estate in the 1980s. The purchase of Rockefeller Center really lit him up. In the slides that follow, you’ll see China’s immense consumption of industrial metals in 2014, a dramatic drop in its GDP contribution from investment in 2015, and the current level of commodity prices.

Conclusion

As usual, we recommend a balanced portfolio with a risk profile suitable for each investor’s tolerance. Participants will not be pleased when they receive their third quarter statements but, hopefully, we have all learned to invest wisely, steadily and with discipline. Good grief.

Full Report with Slides

Water Cooler Wisdom: Fourth Quarter 2014

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Water Cooler WisdomMajor events at the close of 2014, specifically the fourth quarter of 2014, included: the abnormally low prices of oil; the unique position of the Federal Reserve and the US dollar; US Treasury Rates poised (still) to rise; and American manufacturing ramped up to march on ahead of other world leaders, while an embroiled Europe awaits the coming year.

“Returns and Valuations by Style”

Significantly improved from the previous quarter, overall market growth was strong in the final quarter of 2014; though the annual return was less than half of the growth from 2013’s phenomenal success.

“Energy Price Impacts”

By a landslide, the most compelling story of the closing chapter of 2014 was the low oil prices brought upon by OPEC with ferocious Saudi leadership striving to re-establish control of global oil markets. Oil production outpaced consumption, therefore supply outpaced demand, and led to a build in inventories. The supply is not uniformly distributed, though, and the United States is responsible for the fastest supply growth since 2013; however, consumption in the US did not grow nearly as much, and China continues to contribute to the most global demand growth. Notably, Europe and Japan’s consumption declined.

The population most effected by gasoline prices, of course, is the lowest quintile of the population. If oil production declines, and global demand growth picks up, then oil prices could move higher, but if the demand trends persist, and supply growth remains robust with neither the US nor OPEC yielding any production, then oil prices could move further down. Economists overall are split either way, but most agree that the current low prices are abnormal. The Federal Reserve expects that any resulting deflationary pressure from current low oil market prices will be transitory, rather than permanent, and that the economy will achieve the 2% target inflation over time.

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Water Cooler Wisdom

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Water Cooler Wisdom

September 30, 2014

Nothing is private anymore: celebrity photos are leaked across the Internet, everyone knows that Ben Bernanke was unable to refinance his mortgage and we can even follow professional football players’ misconduct. This technology, which allows us to follow the economy more closely than ever, shows that our economy is growing. Over the last quarter, the economy grew 4.6% and it is poised to continue this growth in the long run.

Here is what we expect: the US economy will continue to grow in the short and long term, interest rates will eventually rise (which is a good thing!), and you will be able to manage your money more effectively in a stable U.S. economy.

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Much Ado About Fracking

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On Tuesday, September 17th, I attended a luncheon with the Denver Association of Business Economists (DABE) to hear Garret Nülle, an expert in Oil and Gas Economics speak. Mr. Nülle presented us with a comprehensive overview of the field, including projections of where fracking will go in the future. A few days later, I met with David Tameron, Senior Analyst for Wells Fargo Securities, regarding the role of fracking in the economy. The following post is the product of these conversations. 

From slides of Mr. Nülle's presentation
From slides of Mr. Nülle’s presentation

The popular term for Shale Drilling or Hydraulic Fracturing, “Fracking”, polarizes as many groups of people as other hot-button topics. But, like it or not, the energy investment community sees shale drilling as a permanent part of our energy source. The US has actually used fracking since the 1940s; as a part of oil and natural gas resources for the last 60-odd years, about 35,000 wells use the hydraulic fracturing method. An estimated 80% of natural gas is estimated to require hydraulic fracturing for extraction in the next decade. So, the number of rigs currently involved in production and the US market should continue as the most established for the next two decades.

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