J.K. Rowling Speaks at Harvard Commencement

J.K. Rowling Speaks at Harvard Commencement from Harvard Magazine on Vimeo.

Elif Batuman in conversation with Richard Fidler

US writer and academic Elif Batuman fell in love with the great Russian writers after reading 'Anna Karenina' some years ago.

Broadcast date: Tuesday 31 August 2010 (612 ABC Brisbane)

Elif has discovered that when you read a truly great novel, it can work as a kind of vortex - drawing you into its world and its passions, and if you're not careful you can end up making important decisions about your own life as a result.

She wanted to explore the link between real life and books, and when she decided to chase up the lives and stories of the likes of Tolstoy and Dostoyevsky, she had no idea of the extraordinary places it would lead her.

Some of the many things she discovered on her bizarrre journey include the discovery that Isaac Babel once met and probably interrogated the creator of the original King Kong movie on a Polish battlefield - and that in the old Uzbek language they have 70 words for duck.

The Possessed: Adventures with Russian Books and the People Who Read Them published by Text

Brisbane Writers' Festival: Thurs 2 Sept GoMA Cinema A 2.30 pm/Sat 4 Sept The Edge 1.30 pm

LISTEN TO CONVERSATION HERE (ABC LOCAL RADIO)

Building Resilience

Jim Parker, Vice President, DFA Australia Limited
August 2010

'Risk' means different things to different people, but a common definition is as 'uncertainty'. Now, an entire science is being built around the idea of how we can cope better with the unknowable. And it has interesting parallels with investment.

What's known as 'Resilience Science' was the subject of a recent fascinating documentary on public radio in Australia, as an array of scientists revealed how new techniques are being developed to help society cope with rapid and unexpected economic, environmental and social change.¹

"People are beginning to realise more and more that systems don't actually behave like we think they do," says Dr Brian Walker, a researcher with Australia's Commonwealth Scientific and Industrial Research Organisation.

The mistaken supposition, Dr Walker says, is that self-organising systems behave predictably and uniformly with small changes accumulating over time.

"But ... there are limits to the degree to which a system can cope with a shock and reorganise to keep functioning the same way," he says. "And once it goes past that limit, which we call a threshold or tipping point, it still keeps self-organising, but in a different direction, and often one that we don't like."

The role of resilience scientists, then, is to find and identify safe operating techniques within this system so that they can continue to cope when the unknowable and totally unexpected occurs.

Environmental journalist and author Mark Scheilstein provided an interesting analogy in citing the recent disastrous oil spill in the Gulf of Mexico or the flooding that followed Hurricane Katrina in 2005.

"When engineers look at major projects—whether levees in New Orleans or an oil rig in the Gulf of Mexico—not only do they have to plan for things they know about, but they have to plan for things they don't know about," he says.

"What happened in both of these instances is a very similar failing, in my mind on the part of the engineers" in that they failed to account for residual risk beyond the realms of their traditional expectations, Scheilstein says.

In environmental science, resilience is developed through building of reserve capacity, developing what's known as "modularity", diversifying food and energy sources, incorporating the idea of sustainability and increasing efficiency so that large exogenous shocks can be managed without the system falling apart.

Interestingly, similar ideas were explored in a financial market context in Sydney recently when Reserve Bank of Australia deputy governor Guy Debelle spoke to a conference on the concepts of risk and uncertainty.²

Debelle made the point that before the global financial crisis, many market participants had fallen victim to a form of hubris, believing that risk was totally quantifiable when in fact there would always be a degree of persistent uncertainty in the system that no model could account for.

"I don't want to get too 'Rumsfeldian' here, but an important element of risk management is to know what you don't know," the central banker said.

Because it was impossible to measure what we don’t know, policymakers and market participants needed to find ways of making the financial system as robust as possible in the face of this inherent and irreducible uncertainty.

So international policymakers in Basel are considering new requirements such as limiting the leverage of financial institutions, delivering a more robust funding structure to banks and enhancing their capital buffers.

Even then, the Reserve Bank deputy governor warned that no single model or combination of models can totally eliminate uncertainty.

"Risk measurement based on historical models can only take you so far. Judgement must play an important role," Debelle said. "Ultimately, the future is uncertain, in the sense that it cannot be quantified. The goal should be to design systems that are as robust as possible to this uncertainty."

The science of resilience is not unlike the approach to investment risk that Dimensional employs. That is, we must not only prepare for risky events that are within the confines of a neat model, but also must take account in our processes of what we don't know—outcomes beyond our conception.

This is achieved by building flexible, resilient, robust and dynamically integrated investment processes that can withstand rapid and unexpected change while maintaining the desired strategies.

Uncertainty in investment outcomes is dealt with through broad diversification, both across and within asset classes. The emphasis is on reducing the impact of idiosyncratic risk in a portfolio and focusing instead on risks that bear a long-term relationship to return.

Substitution is another technique. Traders are given discretion by being able to execute with a wide set of available orders. Not being wedded to an index or having strong convictions about particular securities also gives the investment team the sort of flexibility not available to other managers.

"Modularity" in science means the existence of modules within a network that can communicate and cooperate with each other, but which can operate independently if required. So it is with Dimensional's global investment process—with trading desks in Austin, Santa Monica, Sydney and London dynamically integrated but able to be self-sufficient if needed.

Finally, resilience science incorporates the idea that there are multiple ways of knowing and that our understanding of nature is always evolving. Creative solutions often emerge out of this process.

Dimensional takes a similar approach to investment, always testing its assumptions and encouraging a continuing dialogue between those who pursue theoretical research, those who do the practical implementation and the clients who keep us aware of their changing needs.

Ultimately, building resilience amid uncertainty is what our business is about.

1. Resilience Science, ‘Future Tense’, Australian Broadcasting Corporation, August 26, 2010

2. Guy Debelle, ‘On Risk and Uncertainty’, Risk Australia Conference, Reserve Bank of Australia, August 31, 2010

Sparking creativity at work: Michael Rennie

 From Life Matters on ABC Radio National

The modern business environment is anti-creative, says Michael Rennie, but every business wants to be more innovative, more creative.

And creativity makes us feel happy and productive. So why are so many workplaces the antithesis of buzzing, creative environments?

Why is creativity generally associated with the arts, not with business?

A conference in Melbourne next month called Creative Innovation will try to bridge these worlds, by bringing poets, musicians and thinkers together with business leaders.

One of the speakers has already crossed that bridge. He's Michael Rennie, Managing Partner of McKinsey and Company in Australia and New Zealand.

LISTEN TO AUDIO OF INTERVIEW HERE (ABC RADIO NATIONAL)

Taking Out the Middle Man

 Jim Parker, Vice President, DFA Australia Limited

One of the great benefits of the global internet is the scope it gives investors to test the veracity of media coverage by going straight to the source. Now, one canny consumer is taking this disintermediation a step further.

The structural crisis in commercial media has been cited before in this column, but boils down to the death of its traditional business model as advertisers and readers migrate to the web. The upshot is the media is left with fewer journalists to fill ever expanding amounts of white space and empty air time.

Some in the media are responding to this crisis by heading down-market. Essentially this means they are seeking to make a virtue of their lack of imagination and resources by sacrificing good information and context for public relations spin, circus-style entertainment and unadulterated opinion.

This is why TV business programs regularly feature people shouting over the top of one another and making a mountain over issues that really have little bearing on investors’ long-term returns. Overlooked amid all the sound and fury is the need for solid, independent reporting that adds value for readers and viewers.

One possible response to this noise is to go straight to the source. You can do that in the internet age. Instead of relying on second-hand and often inaccurate reports of, say, the International Monetary Fund’s global economic forecasts, investors can read the institution’s own summary on its website.

Smart consumers of media can also, using modern technology like RSS feeds and Twitter, follow the writers, bloggers and commentators they trust. Google Alerts provide another way to filter news of interest from the flotsam and jetsam.

In many ways, what is happening to the mainstream media is analogous to the crisis that started hitting the recorded music industry a decade ago. The old distribution model has been made redundant and consumers are empowered to access and customize the information they need directly.

One noted UK blogger and comedian, Tom Scott, has taken this trend of disintermediation a step further by designing amusing “journalism warning labels” that are attached to newspapers to alert consumers about the content therein.

Among the individual labels are “Warning: Statistics, survey results and/or equations in this article were sponsored by a PR company.” This is not surprising, given that one 2008 UK university study, based on 2,000 articles in five major British newspapers, found 80 percent of the content was second-hand. Most of it came either from public relations material or agency copy.

Taking note of this trend, Mr Scott has another warning label for newspapers that reads: “This article is basically just a press release copied and pasted.”

The growing dependency of journalists on media and publicity agents for softball interviews is highlighted by a fourth warning: “To ensure future interviews with subject, important questions were not asked.”

But probably the most salient warning label for investors is the one that reads: “Journalist does not understand the subject they are writing about.”

The fact is so much of what vexes investors comes from media content generated by journalists so pressured by deadlines and so desperate for content to fill the gaps between the ads that they really have little grasp of the often complex issues they are called to cover.

That’s the bad news. The good news is the very idea of the “media” – the thing that stands between consumers and events – is becoming rather quaint. The unadulterated information is there if you know where to look.

Broke and Broker

Jim Parker, Vice President, DFA Australia Limited

Each day, terabytes of broker research clogs the email inboxes of money managers. But how reliable are these multitudes of forecasts? New research in the Australian and the US markets helps answer that question.

Ploughing through broker calls is a professional hazard for those money managers who base their value proposition on the notion that they can make consistent returns for their clients by exploiting perceived market mispricing.

The hope is that among the volumes of forecasts will be the gem that will earn investors big money. But it seems there is growing disillusionment among forecasting-based fund managers about the quality of the broker calls.

Australian financial markets research specialist East Coles regularly surveys fund managers about the research they receive. Results of its most recent Best Broker poll featured in The Melbourne Age.¹

The overwhelming impression left by the findings was that managers’ reliance on analyst recommendations has diminished over the years, in part because of concern over inaccurate forecasts and in part due to the perception of potential conflicts of interest between analysts and the investment banking and brokerage businesses of their employers.

"We rely on it [research] a bit,” one fund manager is quoted as saying, “which is unfortunate because it has been wrong throughout 2009."

Fuelling the cynicism was an absence of warnings over a number of high profile corporate collapses in Australia during the financial crisis, including the failures of Allco Finance, Babcock & Brown and ABC Learning Centres.

For instance, in September 2007, an analyst at a major investment bank reaffirmed his ‘buy’ rating on ABC Learning Centres after the company announced plans for further global expansion and said it would lift fees.²

ABC Learning at that time was one of the world’s biggest listed operators of child care centres, with more than two thousand centres operating in Australia, New Zealand and the United States.

Within a few months of that ‘buy’ rating being issued, ABC’s shares had collapsed from above $5 to zero and the company went into administration by September 2007 under the weight of $1.5 billion in debt.

In January 2008, an analyst from a high-profile Australian investment bank issued a report with an “outperform” recommendation on the Queensland property development group MFS and a 12-month price target of $7.15 from the then price of just under $4. A week later, the shares had collapsed by 75 per cent to $1.³ MFS subsequently went into liquidation.

For sure, there are good broker calls as well. But the East Coles survey found these are few and far between, which leaves fund managers wondering whether they would be better off with a dart board.

Further evidence of persistent inaccuracy in broker forecasts came in another recent survey, this time on the US market and carried out by management consulting firm McKinsey, updating a similar survey almost a decade ago.⁴

Analysing earnings forecasts for S&P-500 companies over a quarter century to the end of 2009, McKinsey found that with few exceptions aggregate earnings forecasts tended to exceed realised earnings per share.

Actual growth surpassed forecasts only twice in 25 years, the consultancy found, and both times during the recovery following a recession.

Instead, the survey found the most accurate expectations were actually those built into prices on capital markets themselves.

“This pattern confirms our earlier findings that analysts typically lag behind events in revising their forecasts to reflect new economic conditions,” McKinsey said. “Executives…ought to base their strategic decisions on what they see happening in their industries rather than respond to the pressures of forecasts, since even the market doesn’t expect them to do so.”

Good advice – and yet another reason to see market pricing as the best unbiased estimate of expected returns on capital markets.

1. ‘The Broking Analysts Who Make the Really Big Calls are Few and Far Between’, Michael Evans, July 17, 2010

2. ‘Childcare Giant ABC Tipped to Lift Fees’, The Courier Mail, Sept 15, 2007

3. ‘Debacle at MFS a Lesson to Others’, The Australian, Jan 21, 2008

4. ‘Equity Analysts: Still too Bullish’, McKinsey on Finance, Number 35, Spring 2010, McKinsey & Company

Missed it by that Much!

Jim Parker, Vice President, DFA Australia Limited

 

Market timing is hard; so hard that even the most experienced and respected market professionals struggle to finesse their exit and entry points. Just ask the famed hedge fund manager Barton Biggs.

Biggs made his name as chief global strategist with Wall Street investment bank Morgan Stanley. These days, he runs his own hedge fund and remains a regular media commentator on market trends.

In early July 2010, when market sentiment was the worst it had been since the crisis, Biggs announced he had sold half his equity holdings. Stocks had fallen nine times in 10 days and all the talk was of a double-dip recession.

“I’m not putting my money into anything,” Biggs said at the time. “I’ve taken basically all of it out in the US, and we had a broader exposure to consumer stocks and just, in general, I’ve reduced my net long position by about 30 or 40 percentage points.”¹

That was a shame, as that point in early July marked the beginning of a turnaround in stocks that took the S&P-500 up more than 8 per cent in the intervening four weeks. Bolstering sentiment were solid earnings reports and more encouraging signs on the US and global economies.

In a radio interview with Bloomberg at the end of July, Biggs said he had now changed his mind and was rebuilding his positions in stocks.

“Economic data around the world in the last 10 days to two weeks has turned more positive,” he said. “It has exceeded forecasts almost without exception. The odds of the world slumping into a significant slowdown have diminished.”

None of this is intended to reflect poorly on Biggs’ skills as an investor. He clearly has a large market following and there appear to be plenty of people willing to back his judgment on perceived turning points.

But it does show the great difficulty facing even the most experienced and well informed investors in perfectly judging when to get into or out of the market. For everyday investors, then, the challenge must be even harder.

Research group Dalbar has charted this challenge for many years in its quantitative analysis of investor behaviour, a survey that shows investors almost ritually make the mistake of buying high and selling low.

In a recent interview with Barron’s, Dalbar founder Lou Harvey pointed out that many investors missed the boat yet again in 2009 by moving into safe investments like cash and missing the upturn when it came.²

The best protected investors, Dalbar found, were those who worked with advisors that put their clients first. By contrast, do-it-yourself investors tended to underperform those advised by a fiduciary.

“We found that people working with fiduciaries, advisors with a legal obligation to put the client first, and whose personal assets were on the line, tended to be among the winners - these clients were well protected,” Harvey said.

So it’s a familiar story. Investment advice is not about making predictions about the market. It’s about education and diversification and designing strategies that meet the specific needs of each individual. Ultimately it’s about saving investors from their own, very human, mistakes.

And, as we’ve seen, even the best of us make those.

1. ‘Biggs Buys Stocks Three Weeks After Cutting Holdings’, Bloomberg, July 26, 2010

2. ‘Did Investors Learn Anything From 2008’s Crash?’, Barron’s, July 24, 2010

"Rates Can Only Go Higher"

Weston J. Wellington, Vice President, Dimensional Fund Advisors

It seemed so obvious. With the economy slowly recovering last year from the worst recession in decades and the federal government seeking to tap the credit markets for over $2 trillion to fund an ambitious spending program, both laymen and experts alike seemed to agree that interest rates had nowhere to go but up. The yield on the ten-year U.S. Treasury note as of June 30, 2009 was 3.52%, down from 5.25% in June 2007 but well above the 2.09% level registered amidst the depths of the credit crisis the previous December. With retail sales and housing activity showing signs of gradual improvement, the only question appeared to be how much higher interest rates would go.


Among fifty economic forecasters surveyed by the Wall Street Journal in June 2009, forty-three expected the ten-year U.S. Treasury note yield to move higher over the year ahead, with an average estimate of 4.13%. Seven expected a rate of 5.00% or higher while only two predicted rates to fall below 3.00%. The result? The ten-year Treasury yield slumped to 2.95% on June 30, 2010 and rates on 30-year mortgages fell to their lowest level since Fannie Mae began tracking them in 1971. How many of us would have expected this during a period when gold prices soared over 33% to a record high?


Some observers may be tempted to poke fun at these hapless “experts”, implying they are incompetent or poorly informed. This interpretation is flawed since it suggests that a better team of experts would achieve a more accurate result. A more useful explanation is that even the most talented analysts are unlikely to make reliable predictions and the poor showing by this particular group is simply what we would expect to see, just as often as not, if markets are working freely and fairly. Today’s bond prices already reflect expectations for tomorrow’s business conditions and inflation and these expectations can change quickly in response to new information. However tempting it may be to believe that we can predict the future better than other market participants through careful study, the results of the Wall Street Journal survey as well as numerous other efforts suggest this confidence is misplaced.


What is the message for investors? Predicting interest rates and bond prices is no easier than predicting stock prices, and making decisions based on what appear to be certain outcomes at the time can often prove costly. Many investors reconfigured their portfolios in anticipation of higher interest rates and have penalized their results while they are waiting.

Instead of seeking to predict the unpredictable, investors are much more likely to enhance their results by focusing on the elements they can control – risk exposure, diversification and minimizing costs and taxes.


Yahoo! Finance www.yahoo.com accessed July 7, 2010. Wall Street Journal Forecasting Survey www.wsj.com accessed July 7, 2010. Prabha Natarajan and Matt Phillips. “Stocks Drop; So Do Mortgage Rates” Wall Street Journal, June 25, 2010.
Mark Gongloff. “Two Treasury Forecasts: a Grand Canyon-Sized Gap” Wall Street Journal, April 10, 2010.
Tom Petruno. “Gold Hits Record as Investors Seek Haven” Los Angeles Times, June 9, 2010.

Sugar: The Bitter Truth

Robert H. Lustig, MD, UCSF Professor of Pediatrics in the Division of Endocrinology, explores the damage caused by sugary foods. He argues that fructose (too much) and fiber (not enough) appear to be cornerstones of the obesity epidemic through their effects on insulin. Series: UCSF Mini Medical School for the Public [7/2009] [Health and Medicine] [Show ID: 16717]

Jim Parker's New Book

Jim Parker, VP at Dimensional, has just published his new book, Outside the Flags 3: Discovering the Value of Good Advice.

In this book, the third collection of articles from his web column Outside the Flags, Jim Parker uses these topical issues to highlight the value of good advice:

• Crises come and crises go, but lunches are still not free, return rarely comes without risk and patience remains an under-rated virtue.
• If you are worried about bad news, chances are it is already in the price. Investing is about what comes next. We don’t know that so we diversify.
• You don’t need luck to be a good investor. More useful are patience, discipline, a focus on costs, a willingness to diversify and a decision to take only those risks that come with a long-term reward.
• The media builds neat narratives from messy reality. While often interesting, these are not something to base an investment strategy on.
• Investors grappling with market turmoil often question the value of financial advice. Better to ponder the cost of bad advice.

 Please contact me directly if you would like a copy of Jim's new book.

Marco Pantani - 'Il Pirata' (the pirate)

Marco Pantani Jan 13, 1970–Feb 14, 2004 (died at age 34)
Italian road racing cyclist, one of the best climbers in professional road bicycle racing. He won the Tour de France and the Giro d'Italia in 1998... His career was beset by drug abuse allegations after a failed blood test in the 1999 Giro d'Italia. He died after a cocaine overdose in 2004...
Miguel Indurain, five-times Tour de France winner, paid tribute by saying:
"He got people hooked on the sport. There may be riders who have achieved more than him, but they never succeeded in drawing in the fans like he did."^[13]

http://en.wikipedia.org/wiki/Marco_Pantani

Fausto Coppi - "Campionissimo"

Angelo Fausto Coppi, 15 September 1919 - 2 January 1960 (died at age 40)
Comparing riders from different eras is a risky business subject to the prejudices of the judge. But if Coppi isn't the greatest rider of all time, then he is second only to Eddy Merckx. One can't judge his accomplishments by his list of wins because world war two interrupted his career just as world war one interrupted that of Philippe Thys. Coppi won it all: the world hour record, the world championships, the grands tours, classics as well as time trials. The great French cycling journalist, Pierre Chany says that between 1946 and 1954, once Coppi had broken away from the peloton, the peloton never saw him again. Can this be said of any other racer? Informed observers who saw both ride agree that Coppi was the more elegant rider who won by dint of his physical gifts as opposed to Merckx who drove himself and hammered his competition relentlessly by being the very embodiment of pure will.^[14]
Coppi broke the world hour record on the track in Milan on 7 November 1942. He rode a 93.6 inch (2.43 metre) gear and pedaled with an average cadence of   103.3rpm.^[15] 
The record stood until it was beaten by Jacques Anquetil in 1956.^[9]
http://en.wikipedia.org/wiki/Fausto_Coppi

Working in a Coal Mine

Jim Parker, Vice President, DFA Australia Limited

A recent media article hyped resource stocks, just a day before the Australian government slapped a big new tax on mining. Chalk it up as another reason not to stake your investment strategy on a single sector.

The illustration in The Australian Financial Review¹ showed a miner's pickaxe breaking the dirt, showering sparks and diamonds. The accompanying text proclaimed that investors couldn't afford to ignore mining stocks.

Citing the extraordinary demand from China for raw materials, the newspaper said its own analysis showed the 100 best performing materials shares over the past five years had posted a median annual gain of 33 per cent.

The upshot, said the paper, was that investors needed to improve their knowledge of mining stocks to sort the speculative commodity plays in the equity market from the tried and trusted resource houses.

This all sounded very sensible…at least until the federal government the very next day unveiled a major tax reform package that had as its centrepiece a 40 per cent tax on the profits of mining companies.

Shares in global miners BHP Billiton and Rio Tinto lost 5.5 per cent and 7.5 per cent of their market value respectively over a couple of days. One broker estimated the tax, which takes effect in 2012, could reduce the companies' earnings by 17 and 21 per cent respectively in the first year.²

Of course, such companies as BHP and Rio are influenced by more than a single government's tax regime. Their market performance also came at a time of mounting concerns over Europe's debt crisis and its impact on global growth, a major determinant of commodity prices.

But this episode is yet another demonstration of why people should not seek to build their investment
strategies around a single idea or industry sector. There may well be a "commodity super cycle" underway, as some economists say, but investing this way introduces sector-specific and stock-specific risks that can be diversified away.

Dimensional breaks down equity portfolios not into mining stocks and banking stocks and healthcare stocks, but into broad asset class categories where the risk is related to an expected return.

This means a properly diversified portfolio will include large stocks and small stocks, growth and value stocks, domestic and international stocks and emerging market stocks. The exact mix will be determined by the needs and risk appetites of the individual investor.

It should be said that some of these portfolios may well include BHP and RIO, particularly if the investor chooses a dollop of large cap stocks. But the important point is that the portfolio is not built around a view about the mining industry or its prospects.

Ultimately, successful investing is not only about successfully capturing risks that offer an expected return, but reducing risks that do not. That means limiting one's exposure to random forces and not falling into the temptation of basing an investment strategy on an economic forecast.

Otherwise, it is like working in a coal mine—dark, dirty and dangerous.

---

¹'Your Guide to Mining Stocks', The Australian Financial Review, May 1-2, 2010

²'Rudd Tells Australian Miners He'll Pursue Tax Plan', Bloomberg News, May 5, 2010

Esther Duflo’s TED talk

Esther Duflo - Short Bio

http://www.povertyactionlab.org/

Facebook and Twitter

from @SocialMedia411 ...

Facebook is for people you went to school with. Twitter is for people you wished you went to school with.

Follow me on Twitter: @matthews24

Talking About a Revolution

Jim Parker, Vice President, DFA Australia Limited

Australia's financial advice and retirement savings industries are about to undergo a revolution aimed at protecting investors, curbing conflicts of interest, lowering costs and improving transparency.

At the centre of reforms, unveiled by the federal government recently, is a ban on commissions paid by fund managers to financial advisors and on any other conflicted remuneration structures. The ban applies from July 1, 2012.

The reforms came out of an inquiry called by the government after a series of scandals in which investors were shoehorned into inappropriate investments by advisors compromised by sales incentives.

Alongside the ban on commissions, the government plans to introduce a statutory fiduciary duty requiring advisors to act in the best interests of their clients and to put their clients' interests ahead of their own.

The reforms have received almost universal approval from industry bodies, including the Investment and Financial Services Association, the Association of Superannuation Funds of Australia and, in a more qualified way, by the Financial Planning Association.

A separate inquiry, meanwhile, is seeking to simplify and make more efficient Australia's system of compulsory superannuation, or retirement savings. A preliminary proposal is for the creation of a single, low-cost, simplified and diversified investment strategy for the vast bulk of Australians who do not want to exercise choice in superannuation.
Taken together, the reforms are seen likely to strengthen advisory businesses that already employ fee-for-service models and which are not compromised by compensation provided by fund managers.

This is close to the new model of advice long promoted by Dimensional — one in which the interests of the client are paramount. In the old model, a product manufacturer paid commissions to an advisor (in reality, a facilitator), who in turn sold proprietary products to a customer. In the new model, the pyramid is reversed so the advisor's interests are aligned with those of the client.

In this view of the world, clients are much more inclined to stay the course and meet their financial goals. They get what they really want — help in making wise financial decisions. Advisors become true fee-based professionals, focusing on the needs of their clients and freed from having to "sell product".

The other aspect of the reforms — creating a more efficient retirement savings system — also ties in with Dimensional's long-established message. That message says that investors should focus more on things within their control, like keeping costs down and reducing taxes, and less about factors outside their control, like market volatility and media noise.

It truly is a revolution. And it has been a long time coming.

Hard Sells, Harder Lessons

Jim Parker, Vice President, DFA Australia Limited

Sometimes you need to see the worst practices of the financial services industry to understand why it is worth paying for good advice. Take, for instance, what's been happening in New Zealand.

Huljich Wealth Management is an accredited distributor of KiwiSaver, a voluntary work-based savings initiative set up by the New Zealand government to encourage Kiwis to grow wealth for their retirement.

The Securities Commission launched an investigation into Huljich after the company's founder, principal shareholder and managing director Peter Huljich admitted he propped up the fund with his own money in 2008.

Huljich later admitted his wrongdoing and resigned as managing director and chief investment officer. While the firm insists no member lost money as a result of his actions, the controversy has hurt the company's reputation.

At the same time, the Securities Commission has expressed concern over aggressive marketing techniques by distributors of KiwiSaver, including high pressure door-to-door selling and inducements to sign up right away. Huljich is alleged to have been one such aggressive marketer.

"The commission has become aware of a number of circumstances where KiwiSaver membership has been solicited in an unusual or confusing manner. This type of behaviour is completely unacceptable and damaging to investor confidence," commission chairwoman Jane Diplock said.¹

According to one newspaper, Huljich sold the superannuation scheme to two intellectually disabled students who had little idea what they were signing. One was under the legal age and the other had a reading age of 8.


In some cases, investors did not know they were committing to KiwiSaver. Some thought they were purchasing household products. In other cases, inducements were offered for long-term membership. Some people were even offered the chance to win a $100 shopping voucher if they signed up.

The controversy over KiwiSaver is not what the New Zealand financial services industry needs, as it struggles to restore its collective reputation after a series of scandals in recent years involving finance companies.
A total of $1.5 billion of investors' hard-earned savings were lost in those collapses in 2007-08, a blight on the New Zealand securities industry that the commission's chairwoman blames on a patchwork regulatory framework.²

A common theme in the scandals is a lack of understanding among the general public about the difference between an independent financial planner and a sales person for a product distributor. The latter receives incentives to sell product, while the former is paid by their clients to build a customised financial plan — including a diversified investment portfolio - designed around their individual needs, aspirations and risk appetites.

The government is now attempting to address this by putting up for discussion a draft code of conduct for authorised financial advisors, which sets minimum standards of competence, knowledge and skills, ethical behaviour and client care which advisors would have to meet.

At the core of the code of conduct is a requirement that when providing advisory services, authorised advisors must place the interests of their clients first and must act with integrity.

Advisors would not be able to characterise their advice as "independent" when they are being paid by a person other than the client or are under a contractual obligation to recommend a particular product.

Dimensional has long argued that financial advice is best left to independent and professional advisors who are directly familiar with their clients' financial experience, risk tolerances and individual goals.

The relationship between Dimensional and advisors is not tainted by commissions or other incentives. Rather, it is founded on shared ideas about how markets work, a joint commitment to education and a common goal in ensuring clients have a good investment experience.

The investment philosophy is also a sound one. No market timing or forecasting or speculation is involved. It is not about fickle fashion or ego-driven claims by individuals about being able to "beat" the market.

Instead, it is about working with the market to build diversified portfolios around risks that rigorous research shows are related to return. It is about keeping costs as low as possible and about being mindful of taxes. And it is about staying disciplined.

There are no hard sells in this view of the world - just an unchanging commitment to the welfare of the individual investor.

---

¹'NZ Commission Warns KiwiSaver Funds', NZPA, March 24, 2010

²'The System is Broken: We Need to Fix It', Jane Diplock, NZ Herald, March 26, 2010

Mission Impossible

 Jim Parker, Vice President, DFA Australia Limited

It's a Hollywood staple. A group of ragtag desperados is assembled to embark on a suicidal mission — think 'The Dirty Dozen' and 'The Magnificent Seven'. It makes for exciting viewing, but applying this approach to investment isn't recommended.

At the height of the bear market in early 2009, Australia's BRW magazine, a popular weekly business title, asked 50 market experts to draw up a roadmap for the anticipated recovery, including the best sectors and stocks to buy.¹

The panel of 50 participants comprised fund managers, equity strategists, economists, analysts and other tipsters. From their recommendations, the magazine put together 18 "expert ideas" for the recovery.

The dozen and a half individual stock tips were split broadly between big, well-known, blue-chip companies such as QBE Insurance, BHP Billiton, Woolworths, Westfield, CSL and Boral — alongside some mid-caps, smaller stocks and outright speculative plays.

While couching its stock tips with a host of qualifications — nothing was certain, markets rarely followed a neat script and blindly relying on history was dangerous — the magazine said these were the pick of the bunch.

For the reader wanting to position themselves for the recovery, it might have seemed a reasonable assumption that assembling a concentrated portfolio comprising these 18 super stocks would be a good strategy.

But while parts of the magazine panel's ideal portfolio did do well — mostly the very small, speculative companies — only seven of the 18 stocks overall outperformed the wider market's near 40 per cent gain in 2009.

Indeed, many of the tried and true blue chips in the list underperformed the market. QBE Insurance gained just 5.3 per cent over the year, Woolworths rose 9.1 per cent and CSL actually went backwards, down 1.5 per cent.

If investors had assembled the BRW's 'rebound' portfolio at the start of 2009 and held each stock at its market cap weight, they would have seen a return of 26.8 per cent over the ensuing 12 months.

While that may sound great, it's worth pointing out that just by owning the broad market, as defined by the S&P/ASX 300 accumulation index, investors would have enjoyed a return of 37.6 per cent, a 40 per cent improvement on the magazine's ideal portfolio.

Holding a highly diverse portfolio of value stocks would have delivered an event better result. For instance, Dimensional's Australian Value Trust, with 187 stocks, posted a return in 2009, net of fees, of 43.6 per cent.

Holding such a broad range of companies in a portfolio is called diversification. It allows the investor to capture broad market and economic forces, while reducing the uncompensated risk arising from individual stocks.

This isn't to say you can't beat the market by assembling a focused portfolio. But these successes are usually more down to good luck than good judgement and they are very hard to repeat. It's like taking a punt on a horse.

In any case, as we've seen in the above example, even a portfolio assembled by the best and brightest can come up short of the mark. What chance, then, has the ordinary investor of generating consistent market-beating returns by relying on a handful of securities?

At the end of the day, gambling on a band of hand-picked individuals might work for Yul Brynner and Lee Marvin in the movies, but trying to build long-term wealth with a handful of stocks looks like mission impossible.

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¹'Waiting for the Rebound', Tony Featherstone, BRW magazine, Jan 8, 2009

Birthday of Thomas Jefferson (b. 13 April 1743)

 From The Writer's Almanac with Garrison Keillor

It's the birthday of the man who said: "Determine never to be idle. No person will have occasion to complain of the want of time who never loses any. It is wonderful how much can be done if we are always doing." That's Thomas Jefferson, (books by this author) born in Albemarle County, Virginia (1743). And he certainly lived by those words. He wrote the Declaration of Independence for the fledging United States and then served as its minister of France, secretary of state, vice president, and president. But he was also — among other things — an inventor, philosopher, farmer, naturalist, astronomer, food and wine connoisseur, and musician...

He loved to read ... he said, "I cannot live without books." He wrote to John Adams, "I have given up newspapers in exchange for Tacitus and Thucydides, for Newton and Euclid; and I find myself much the happier."...

He said: "In matters of style, swim with the current; in matters of principle, stand like a rock."


READ THE FULL POST HERE AT THE WRITER'S ALMANAC

http://writersalmanac.publicradio.org/index.php?date=2010/04/13

It Won't Last

Jim Parker, Vice President, DFA Australia Limited

Long-time watchers of financial markets know that investors are always worrying about one thing or another. What's not often apparent is how quickly those worries are built into prices and how rapidly the narrative changes.

The recent fretting points for investors have included, among other things, default risk in southern Europe, the threat of China's economy over-heating, the dependency of risk assets on government stimulus and the implications of proposed regulatory reforms in the international banking industry.

A rule of thumb with a lot of these hot-button financial and economic issues is that by the time you read about them in newspapers and magazines, the markets have moved onto worrying about something else.

Take Greece for example. A search on Bloomberg of the words "Greece and default" yielded nearly 300 news stories in the month of March. The subject of these articles extended from fears of outright default to, by the end of the month, news of a strengthening in the euro as Greek fears receded.

A search of the word "stimulus" on Bloomberg yielded more than 600 news articles in March, extending from Brazil's attempt to lure investors with infrastructure spending to news that Japan's retail sales were growing at their fastest pace in 13 years, thanks partly to government stimulus.

In this age of rapid global information flows, aided by web-based distribution, news is incorporated into prices almost instantly. A geopolitical development like a bomb blast in a Moscow subway, or economic news such as an agreement on a bailout for Greece or company-specific news like a Chinese firm buying Volvo from Ford….all of this tends to find its way into prices before the average person has heard that it has even occurred.

So it shouldn't be a surprise that many investors err by tinkering with their own portfolios based on information that is already reflected into securities pricing. This is like chasing a moving target or trying to catch a falling sword.
No sooner have you pondered, for instance, the implications of Y2K or the SARS virus for your portfolio than the market has decided that this issue is a flash in the pan and has gone onto worrying about something new.

A better approach is to accept that markets are extremely efficient at incorporating fresh information into prices and that trying to second guess how they might react to a particular event is a hazardous game.

By the way, one senior Australian advisor has developed a successful technique for dealing with queries from his clients about the implications for their portfolios of whatever issue happens to be dominating the financial media headlines at that time and whatever the state of markets.

"To be completely honest, I don't know what the implications are," he says. "But I can tell you this: It won't last. Now let's talk about your news."

This seems to be a healthy approach to responding to news that's dominating the markets. It's interesting, it's topical, it's forever changing and, for the most part, there is very little you can do about it.