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Jenny Young of Sweet Briar College Talks About The Naked Portolio Manager
Sweet Briar College student Jenny Young, who is testing rules-based investing models in Professor Tom Scott's "Principles of Investing" class, addressed a small group of investors at a cooking class in Richmond, Virginia last Saturday. Watch the video below to hear what she had to say about The Naked Portfolio Manager.
What You Must Understand About Derivatives and Other Wall Street Creations
A friend of mine recently asked me what I thought of a derivative investment called "equity-linked reverse convertibles." Before I explain my answer, I want to tell you a story about something that happened to me when I was a cadet at West Point.
I was on leave in New York City when I happened upon some men playing a card game. There were only three cards; one was red and two were black. I later learned this game was called Three-Card Monte. One man, who we'll call the "operator," would expose all three cards, turn them over, and then quickly move them around. The objective was to identify the red card. With a minimum bet of $40, you wagered on where the red card ended up. If you correctly identified where the red card was, you doubled your money.
Another player, who we'll call the "mark" a.k.a victim, was dressed much better than the operator who was running the game, and was consistently losing his money. I watched for a while and found it easy to follow the red card. Of course, I was encouraged to play by the onlookers, but $40 was a lot of money to risk back then. Yet I kept watching the mark lose his bankroll, meanwhile, every time I knew exactly where the red card was.
Finally, the lure of easy money proved too great. I pulled out my wallet and plunked down my $40. And for the first time, I guessed wrong! Undeterred, I tried again and guessed wrong again. At this point I was ready to leave, but just then the mark grabbed me by the shoulders. "Hey, let's not let this guy beat us out of our money!" he said, as he implored me to keep playing.
I reached into my wallet and pulled out my last $20. I didn't have enough for a full bet, but they let me slide. I was going to lose anyway. And so $100 dollars lighter, I found a pay phone and called my dad to get him to wire money to Western Union so I could buy a bus ticket back to the Academy.
On the ride home I realized I had been tricked. The supposed "mark" who kept losing his money was not a mark at all. He was actually a shill or a person who encourages others to play a gambling game and a confederate of the operator who ran the game. My initial perception had been entirely wrong. **I** was the mark or sucker.
In retrospect, I could have evaluated the situation differently. Obviously, the fellow running the game was no fool. The game was his livelihood, and he knew what he was doing. It was foolish of me to think I could beat him at his own game.
...Which brings me back to my friend who asked me about the equity-linked reverse convertible. Remember, whenever Wall Street creates a complicated product that's difficult to understand, it's extremely unlikely that ordinary investors are getting the best end of the deal. After all, the people who create these products are highly sophisticated and the game is their livelihood. In "Wall Street Monte," they know how to play the role of the operator.
I told my friend to pass on the equity-linked reverse convertibles. Stick to transparent rules and keep your investment decision-making simple. By using what I call "naked investing" - meaning you know the rules just like everyone else - then you can avoid the bad market odds that come with many of Wall Street's trumped-up creations.
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What's ChangeThis.com? It's a website created by best-selling author Seth Godin, who had a desire to spread ideas designed to make the world a better place. Godin's idea was to create a website where people could submit proposals to write e-books sharing those great ideas. Each month a new batch of proposals would be listed on ChangeThis.com, and voters would "cast their online ballot" for the ones they liked best. Those highest vote-getting proposals would be turned into professionally crafted e-book manifestos for wide distribution through social media.
Since the creation of ChangeThis.com in 2004, many manifestos have been written that resulted in best-selling books. People like Tom Peters, Chris Anderson, David Meerman Scott, and Guy Kawaski have all written manifestos as a result of Godin's website. And this month, my proposal, Time To Get Naked, is being considered along with 19 other proposals. In a nutshell, my proposed manifesto argues that each year investors spend hundreds of millions of dollars in mutual fund fees for investments that perform below the market averages. There's no reason to continue to pay for subpar performance. By using rules-based methodologies, a.k.a. "naked strategies," investors can systematically improve their results and reduce their costs.
So how do we get $20,000 for charity? I'm challenging the other 19 people who submitted a proposal to pick a charity and donate $1 for every vote they get just like I am. If everyone does this, we will raise $20,000 for some wonderfully worthy charities and also spread some great ideas through e-book manifestos and social media.
My chosen charity, Families of the Wounded Fund, Inc. (FOTWF), was created to help the men and women who sustain the most serious injuries while serving in Iraq and Afghanistan. Many of these returning soldiers are treated at McGuire Veterans Hospital in Richmond, Virginia, where I live. They come from all over the country and very much need their families to be with them during their long and difficult road to recovery. While the federal government provides for their medical expenses, many of the costs of traveling from their homes to be with their injured family members are paid for by the families themselves. And many times, this places a severe financial hardship on them. FOTWF provides funds directly to those that need it most. Village Bank absorbs most of the administrative costs of running the fund so almost 100% of the money donated to FOTWF goes directly to help the families.
To vote for my proposal, go here and click "Yes, please write this manifesto" in favor of "Time to Get Naked." Also, please share the link to this blog post on your Facebook page or profile and/or send an email with this link to your friends who have had the privilege to serve our nation in the United States military.
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How Naked Strategies Can Make April 15th Less Painful Next Year
Sunday's New York Times had an article titled "The Low-Cost Power of Naked Investment Strategies."
Okay, I made that up.
The real title was "The Low-Cost Power of Exchange-Traded Funds." The majority of exchange-traded funds employ rule-based methods, which I of course call "naked strategies." Most are not managed the traditional way using an investment manager's judgment, which is used by the majority of open-ended mutual funds.
The article suggests that assets in exchange-traded funds are growing -- practically eating traditional mutual fund managers for lunch! The Times points out that these kinds of funds have two big advantages over traditional funds. 1. They are less expensive. 2. They are more "tax efficient."
Exchange-traded funds offer a great opportunity for small investors to take advantage of the benefits of naked investing. Affluent investors, on the other hand, should use separately managed accounts. As I explain in Chapter 12 of The Naked Portfolio Manager, rules-based investing is both more economical than traditional mutual funds, and much more tax efficient that exchange-traded funds. This is because when you use an index fund or exchange-traded fund, you have much less flexibility about how and when to take your gains and losses. With a separately managed account, you have a host of tax minimization strategies that are not available to investors who use this fund. For more information, see page 109 and 110 of my book.
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According to Professor Scott, the Sweet Briar composite has returned 11.64% for the first quarter of the year, beat the SP 500's return of 4.87 by more than two to one. That's very exciting, and congrats to the ladies for doing such a GREAT job. You can find a complete description of all the Sweet Briar models, a list of the stocks selected, and monthly performance updates here.
I had the opportunity to interview Laura Jett, one of the "Principles of Investing" students last week. Click here to listen to the six minute interview with Laura. After you listen to what she has to say and review the results at Professor Scott's website, you may find yourself wondering if traditional approaches to portfolio management may well be on their way out. Is rules-based a.k.a. "naked" investing the way of the future? I think so.
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Bob's noteworthy success in the investment field is based upon his in-depth knowledge of decision-making, which he applies in a disciplined, rule-based approach: the application of Statistical Prediction Methods.
