Saturday, November 29, 2008


I reviewed the Vanguard Asset Allocation semi-annual report today and it is time for me to fire that fund.  This fund went to 100% stocks in January 2008 and has stayed at that level since then.  Consequently it is down almost 40% even after the huge rally last week.  This is not an asset allocation.  In the report, the President and CEO, F. William McNabb III, brags that the fund has had an average annualized return of 4% over the past ten years ending on September 30, 2008 and even that paltry amount has probably largely evaporated in the gas that he is spewing in the report during October and November 2008.  I got some news for this guy.  A 100% allocation to stocks for the entire 2008 period for an asset allocation can not be defended, period. There can be no justification for it. It is simply bad asset management. In 1998, I could have bought a 10 year U.S. treasury directly from the U.S. Treasury under its Treasury Direct program, received about a 5.5% yield, paid no one a commission or an expense ratio, and I would have beaten the Vanguard Asset Allocation fund without making another decision during the past ten years on an annualized return basis to 9/30/2008 and smashed the fund's large negative returns over the past two months. The historical data can be found at the federal reserve's site:

The fund is managed by Mellon who claims in the report that their models work. Maybe they need some refinement or retooling for the future. Whatever Mellon is doing, it has failed in my view. 

All of this writing that I have recently done about asset allocation, partly tied to my developing VIX and other volatility models, has caused me to actually check more precisely my current allocation which is a good thing and not easy for me to do.  You would think that I monitor it closely but actually I just guess at it. It is hard to do.  Some of difficulty has to do with multiple accounts and then some funds have bonds, stocks and cash, requiring an adjustment and split. I excluded all retirement accounts, money set aside for a couple years for living expenses, life insurance cash values, home and all other hard asset values, checking accounts,  and the HSA accounts to try to get a figure for my investable assets other than retirement accounts which stay fully invested about 60/40.

After gathering multiple account information, I found that I have over allocated to cash, with money markets, T Bills, a few CDs and a savings account now at 30% of assets so I over did it last year.  I meant to have closer to 20%. I got carried away last year and it is probably just as well that I waited until now to do this with precision.  Stocks (foreign and domestic)  are at  32% and this includes a wide variety of securities in this category including common stocks, mutual funds, and closed end investment companies consisting of about 200 position.  Long bonds and preferred stocks are at about 10% with 30 positions. Short bonds, less than 5 years to maturity and structured in a ladder, are at 14% with 19 positions.  Tax free bonds, intermediate term, come in at 4%.  Bond ETFs, foreign and domestic, bond mutual funds and non-U.S.  currency  constitute the remainder at 14% total, mostly in Bond ETFs and bond mutual funds.  So this is a good exercise for an old man to go through once a year even though it took two hours.  I am under exposed to stocks which means that I need to increase buying over and above my cash flow until I reach a 50% allocation.   I think that I will take my time.  No wonder I am beating the pants off Vanguard's Asset Allocation fund.  I have stuff that is actually up for the year.  Wow.  Doing better than I thought when I pulled it all together.  

I did not mention in an earlier post discussing VXD that you have to go to Marketwatch to find a long term chart of the DJIA Volatility index, VXD. Notable NEWS: C, DK, NYT/Further Discussion of Volatility and Asset Allocation Yahoo Finance does not have a long term chart.  It is better to use the interactive chart and I think that you have to be a member, which is free. You can also highlight a period on the interactive chart to see a bar chart in more detail. I will do that to focus on a few weeks of action.  In my prior post on VXD, I did not highlight the fact that this index did shoot to over 30 intra-day on August 16, 2007, hitting  34.21 before closing at 28.69.  The VIX closed that same day higher at 30.83 and had a high of 37.5.

My earlier point is that the VXD in the high 20s would in my view be confirming the VIX trigger on August 16th which would start the period rolling for a forced reduction when the VIX fell below 20 again which happened starting on September 25, 2007 and lasting until October 11, 2007 (closing prices of the Dow ranged from 13,778 to 14,015 during that period). The second trigger occurred on 11/7/2007 (VXD was then in the mid 20s and at around 27 a few days later), which would cause yet another forced reduction on 12/26/2007 (Dow at 13,551), a one day period.  So there may be no luxury granted to wait for the best price during the down period for VIX and the up period for the market.   Also, unlike the prior forced reductions in 1997 and 2000, BEEPRA VIX LXPPRD/ More on VIX AND ASSET ALLOCATION you would have been better off this time around taking it all off after the first trigger/warning when the VIX returned to below 20 in October 2007 which I may do next time. Around May 2, 2008, and this is one reason for the 3 month rule on reinvesting the cash raised during the forced reductions, the VIX fell to below 20 and stayed below 20 until June 4th. At best, this was a buy SDS opportunity and a sell of SSO.  The VIX then resumed its unstable pattern and entered phase 2 of its instability after the Lehman failure.   

I am trying to emphasize something in my own inadequate way.  You have to remain flexible and you have to make adjustments based on risk tolerance and one's own financial situation.  History will not repeat itself exactly.  Models are not precise.  Informed and intelligent human judgment has to be exercised at all times.  A model needs to be altered by a thinking person to reflect observed changes in the market's behavior. You can not cling to a model that does not work, as Vanguard is doing. You can not cling to a failed model and say it is doing well. I will not do what those quant funds did at Goldman Sachs and elsewhere that could not adjust to changing circumstance. NYT You can not have a model like the ratings agencies that would not even permit you to plug into the model a fall in home prices.Op-Ed Columnist - All Fall Down - 

You can not always assume that the past will repeat itself over and over again in exactly the same way, with no outlying or unanticipated events.

It is almost humorous to me to read Rubin or some other person, making millions, claiming that this crisis could not be anticipated. Yes, of course, it could have been  anticipated, possibly not in the total number of major failed institutions, but in the overall seriousness of the problem. There was plenty of time in 2007 to alter investment strategy to soften considerably the blow to come. What was Rubin and the managers at Citi doing in 2007?. Taking more risk to make more money for themselves. That is what they were doing. When it went bad,  they run to Uncle Sam and say save me or the entire financial system will implode. That is it in a nutshell. What was Rubin doing in 2007, talking bull with Saudi princes and working on the NYT crossword puzzle? Rather than blaming themselves and their own bad judgments, banks always say it was some unforeseen calamity,  something just way beyond their control (even as they participate in the events that cause the meltdown), an unforeseeable event like the Titanic hitting an iceberg or being stroke by lightening while fetching the paper. They have been saying similar things every time they blow themselves up. Robert Rubin's Detail Deficit | Newsweek Business | I heard the same from them when many of them including Citibank almost failed due to commercial and construction loans circa 1990. 

I basically run for myself a balanced asset allocation fund and I do it differently than anyone else that I know.  I will go anywhere and buy anything, no restrictions on assets classes or categories. I do not listen much to the experts, really could care less about what others may say,  and try to find my own way as I have done for over 40 years. It really takes some doing for so many professional to underperform  benchmark ETFS year after year. Everyone has to find their own way, rely on their own informed judgments, learn from experience, think before reacting, do nothing based on emotion or fear,  always try to figure out when to sell into parabolic moves in any asset class (never buying into it) and most importantly tread carefully for the bear is a most powerful animal that needs all the respect that you can give it. Besides, I have just read that corporate bonds have now outperformed stocks since the major secular bull market in stocks started in 1982 so what is the problem with a few bonds in an asset allocation fund- Vanguard?    

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