News

June Commentary

We would all love to have the magic glass that would let us see when the markets are going to move up or down. We would then be famous for knowing just how to time the market. Even the experts, or those people that a Washington Post article referred to as 'America's finest financial engineers' are having a hard time making predictions in today’s market (Quinn, Jane B. 'Absolute-Return' Funds Aren't So Definite. The Washington Post, March 01, 2009; F01.)


Clifford Asness, whose firm AQR Capital Management LLC lost billions from 2007-2008, said in a Wall Street Journal article on May 26, 2009 ('A Hedge-Fund King is Forced to Regroup'), 'We got more wrong than right last year.' According to this article, 'AQR’s flagship Absolute Return Fund, or ARF, fell about 45% in 2008.' 'The market’s chaos last year made a hash of the mathematical models used by quantitative hedge funds such as AQR.'


Hedge funds, as well as many other mutual funds, have been using hedge techniques for years. They practice 'shorting' (betting on a stock falling and then borrowing against it), leveraging various securities, as well as using 'models' that tell them when to move in and out of the market. While different in design, various mathematical formulas were also used to define the derivatives market that was a primary ingredient in this recession. The derivatives were based on securities built on the mortgages that were bundled and sold. We know where that led us.


Additionally, the pressure the "short sellers" put on the market place was also evident in March of this year. This pressure is believed to be responsible, in some part, for pushing the market down to it’s low. To correct this, the SEC will be making changes to the "short selling" rule because of how it managed to disproportionately affect the March market. We expect those changes to come out this month. However, these changes will not affect how our firm rules our portfolios, because we do not 'short sell' or use the various hedging techniques described. We do not use them because these techniques have the ability to "double down" a return. That is like being on the table in Vegas. You could double your money up OR down.


We are now seeing the industry start to try to build some new styles of funds. The newest nickname is "long/short" funds. This involves a play to two sides of the market place. The lesson in this story is that even the "timers" got it wrong and now they are trying to make up for it. Will these be more successful than existing funds?


Back in the 80's, there were under 1,800 mutual funds, and now there are over 20,000. In recent years, there have been more mergers, fold-ups, and changes than ever before. This is, in some part, due to the large universe of funds that now exists. We went back and tried to find successful funds in 2008, and the pickings were slim. Over the last 10 years, it seems new is not necessarily better. We ran a "back test" and found that our client portfolios would have had to have been almost 100% in short bonds to have not had a loss. The problem with mathematical models seems to be that they cannot incorporate the human element in the equations.


ECONOMIC NEWS


May, 2009 has shown less volatility than previous months. In view of the weakness in the overall economy, this is a positive sign. We have observed the credit spreads narrowing substantially, particularly since October of last year. To give you a comparison, in October, when the credit markets froze, lending rates were over 4%. Now they are down below 1%. Credit markets froze in October because financial firms did not want to pay the higher rate. We can see why. Although banks and financial firms still have a long way to go to rebuild their balance sheets, we have seen some positive progress. Some banks managed to sell stock to raise capital, and others are trying to give TARP monies back. This is good news. While everything is not yet well, there is some healing going on.


General Motors is also a big player in the current economic news. While the market has absorbed the numbers on Chrysler, it has yet to integrate the affect of General Motors going into Chapter 11 bankruptcy. We will watch how things roll out throughout the coming months and give you an update if things show some significance.


PORTFOLIO IDEAS


Risk questionnaires are being returned, and many folks appear comfortable with their allocations. Remember, these questionnaires were not meant to suggest to you that you needed to change things. They are a tool to make sure that we have you allocated in such a way as to meet your risk tolerance or risk capacity at this time. As many articles have pointed out, concepts such as dollar cost averaging (DCA) and asset allocation are not dead. They have existed as a tool for decade upon decade, through all kinds of recessions, and are still being used. State pension plans, trusts, and company pension plans all use asset allocation. Many of these also suffered under last years onslaught, and I have not heard of any State Pension plan or trust changing from asset allocation to "timing" the whole pension plan into and out of the market. If those plans had gotten out of the market they would have missed the recent rally.


EARLY WITHDRAWALS ON IRA'S and IRC SECTION 72(t)


Some folks have been laid off short of age 59 1/2, the age at which you can normally take money from your IRA without the 10% early withdrawal penalty. If you intend to make an early withdrawal of IRA funds, the following information may be helpful.


Internal Revenue Code (IRC) Section 72(t) gives you some alternatives to paying the early withdrawal penalty. To avoid the penalty, you may be able to take your distributions each year in a series of substantially equal period payments (SEPP's). This means annuitizing your early withdrawals over a 5-year period, or until you reach age 59 1/2, whichever is longer. The three calculations that can be used are (a) annuitization, (b) amortization, and (c) a minimum distribution method based on your single life expectancy. Each yields a different result in terms of monthly payments, and once started they must remain the same each month. The code changed several years ago to allow for a "one time" adjustment if the choice taken results in a "draw down" on the account.


Other exceptions to the 10% penalty include: disability; inheritance of an IRA; using the funds for excessive medical expenses, health insurance, or educational expenses; buying, building, or rebuilding a first home; as well as a few others. None of these methods avoids the tax on the income you receive, but it does cut out the 10% early withdrawal penalty that would otherwise be imposed. If you would like more information on IRA’s, please see the following IRS publication (Publication 590: Individual Retirement Arrangements) at: http://www.irs.gov/pub/irs-pdf/p590.pdf


UNEMPLOYMENT


While unemployment continues to rise, we can take some comfort in the fact that Richmond's unemployment is lagging behind many other cities across the country. Unfortunately, it is still hitting home for some of our clients. Your children may have been laid off from their jobs, or even some of you are experiencing lay-offs first hand. It is hard to be spared from the difficulties circulating throughout this economic situation. If you have been laid off and are at the right age, you may wish to try to take advantage of a 72(t) .You may also have to consider what to do with your 201(k) (does your 401(k) looked like half of what it used to be?).



Remember that our firm does not sell investment products. Our advice over the years has been within industry standards, to be unbiased and free from any conflicts of interest. You or your child deserves this type of advice, not just a sales loaded group of mutual funds or an expensive insurance product. We will gladly provide this same honest approach to anyone you know that is uncertain about just what to do during this type of transition. Let us know if we can be of service.

Kevin P. Deckert CFP