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Exchange Traded Funds

Exchange traded funds (ETFs) have been in existence since 1993. This makes these investments relatively new as compared with mutual funds. The older traditional way of investing has been finding mutual funds yourself, or hiring a pro to do it for you, and selecting a handful of them. Those chosen are either category-specific or balanced to meet all your needs while at the same time distributing the risk that you’ve requested. Some of the problems that are not disclosed with mutual funds are the hidden costs that can be as high as 5-6% and in some cases even higher. A study done by Morningstar disclosed most fund managers do not own their own fund or have a minimal investment with their own money. Many times the fund management has a different objective. It is important to ask questions and consider past performance and how long the fund manager has been in this position. Fund managers are changed from time to time, and the person making the decisions may not be the person deserving the credit if it is or was performing above the average. The yardstick for measurement is the S&P 500, because this can be purchased as is with a lower cost. S&P Dow Jones has found that not many managed funds are able to consistently reach the top quartile of performance over five successive years. At the end of 2014 it reported 88.44% of large-cap fund managers underperformed the benchmark over a one-year period. Over five and ten-year periods, respectively, 88.65% and 82.07% of large-cap managers failed to deliver incremental returns over the benchmark. Most mid-cap, small-cap, and international managed funds also lagged their benchmarks.

Since the startup of the first ETF in 1993, ETFs have continued to grow and improve, and now we believe can better outperform the index if and when selected properly. Today there are more than 1,400 from which to choose. Many are category specific, while others are balanced to try to fit almost everyone’s portfolio. Today’s ETF investments total $2 trillion and are growing.

Because we do not use mutual funds, it is our belief that a properly diversified portfolio should have many ETFs along with individual standout stocks. This strategy allows us exposure to various segments of the U.S. and international equity markets, and to various trading and investing strategies that require more flexibility than mutual funds provide. Those producing the most are Blackrock (iShares), State Street (SPDRs), Vanguard, Guggenheim, Wisdom Tree, and PowerShares. Two other reasons to add these to portfolios are first, ETFs trade like a stock so the tax consequences are better. One would immediately know the cost basis and not have to worry about any hidden surprises when something within the fund has been sold, and this is not the case with mutual funds. Second, the costs for most ETFs are under 1% and that’s a large savings compared to the alternative. Most have 40-60 individual stocks built within their portfolio.

The Pro’s and Con’s of Mutual Funds

What You Should Know!

One of the big advantages of mutual funds is that they allow the small investor to have professional management and diversification for a small fee. The problem that we face nowadays is that the fund industry has grown and proliferated by merchandising to all and sundry. Most people who have sufficient capital would be much better off with a professionally managed personal account. When an individual has a thousand dollars or less, it is difficult to think of a better place to invest his or her money, than in a mutual fund. However, when a person has several thousand dollars and considers a mutual fund,

These are the disadvantages:

  • In the past, most fund management companies had one person in charge of managing each fund. With so many funds in existence today, it is difficult to find the kind of talent this job calls for. Some management companies are doubling up and have one manager for two funds. Naturally, such a large task is difficult.
  • There are more mutual funds today than there are securities on the New York Stock Exchange. This makes selection more difficult.
  • Sometimes a mutual fund is so large, that it might be priced out of some purchases. Management can only watch so many securities and this means that a large fund may not be able to invest in a company, simply because that company has a small capitalization. A small company has more growth potential.
  • The fund manager is managing for thousands of people and these people might have differing thoughts on areas of investment. The personal money manager is handling each account for one individual and the investments are scaled to comply with this client’s wishes.
  • In reality, a mutual fund investor is purchasing proportionately every stock in the fund’s portfolio. The investor may buy a fund today, only to find that management has sold one or more of the stocks at a profit. Although the manager may have done a good job, this does not work to the new investor’s advantage. He may have purchased the fund when U.S. Surgical was selling at 140, only to find that it was sold when the stock started downhill and got out at 120. This investor has actually taken a loss, but the firm may have bought it years ago at 20, showing a 100 point profit. The new investor must pay taxes on a profit even though he has taken a loss.

In reviewing the portfolios of our clients, we find that approximately 1/3 of their holdings were concentrated in 20 stocks. These are the companies that we consider to have the best outlook over the coming period. Compare that with the situation of a mutual fund holder. His money is spread over 100 or 200 stocks. I would not expect the last 20 stocks in the fund to perform as well as the first 20. With an individualized management account, the management fee is deducted and the amount made plain to the investor. In this manner, he may apply this cost against his income tax. In mutual funds, this is not done. The fee is deducted, but the investor never knows the dollar amount.

Information has been obtained from sources deemed to be reliable. Pearson Capital, Inc. makes no guarantee as to the accuracy or completeness of this data. Information is provided for informational purposes only, and Pearson Capital, Inc. shall not be liable for any errors or omissions, or for any actions taken in reliance thereon.

When Should We Sell

Every broker, financial planner, and investment advisor that I know addresses this part of the business differently. As I review the portfolios transferring into our management, in many cases no one focused on the selling part, and this could be the most important reason for a portfolio’s under performance. As often as needed, their formula for selling should be reviewed for each client and overhauled when necessary. We see over and over that the time needed for research to sell is not given the same priority as the amount of time set aside for buying.

It is my opinion finding the right stocks to purchase to build a well-diversified portfolio is one of the most difficult endeavors one can do successfully. I will also add that selling at the right time can produce the same, and in many cases, more benefit for the overall portfolio’s success, although this is an even more difficult challenge. The most important lesson to learn about selling is no one will be right all the time, yet if you remain committed to your system, and if it’s a good one, you can be right more often than not, and this will produce very favorable results.

One of the reasons we continue to advocate a portfolio size of 48-60 stocks, ETFs, and other entities, is so that no one stock can maintain a large enough percentage to impact overall performance. If each holding is approximately 2%, and it suffers a 40% negative price adjustment, it still is less than 1% of the overall portfolio. Occasionally we are asked why we sell so little, while occasionally others believe it’s too often. I can tell you when a portfolio is built, we believe nothing will be sold for at least three years. Everything bought is perceived as undervalued with double digit growth projected for several years. It is the unknowns and the unexpected that triggers the sell. It might be competitive activity, market change, poor performance, or a host of other variables. A client once said to me, you’ll never have to apologize to me for taking a profit. I’ve also learned if we enact the sell because the indicators say we should, it’s comforting to know our research team has a suitable replacement waiting. Sometimes the trading fee might be the best bargain of the year.

Market View

Christopher Carothers
PCI’s Stock Analyst

For the past 12 years I have done extensive investment research as a member of the Pearson Capital management team. My background consists of a degree in Finance from the University of South Florida with a minor in Economics. My everyday activities as a research stock analyst consist of analyzing data available from a multiple sources as it applies to the companies we are researching. With this information I can then make short-term and long-term evaluations on a company’s present and future performance. There are many other variables today that also impact the performance of these companies and the overall stock market. Each month I will share with you my thoughts on the segments and issues I believe to be the most important and the impact they are causing on today’s economy. Economic flows of money, earnings and cash flows of companies are extremely important in the day-to-day performance of the stock market. Economic flows involve the action of the Federal Reserve, the 10 year bond, the valuation of the dollar and other economic factors. Earnings flow focus on the strongest stocks and sectors reporting in the market, while cash flows focus on those companies that take in more money then they spend. Each month I will go into more detail about these specific subjects and summarize my day-to-day evaluations in a monthly article.

Shorting Explained

SandraBy Sandra Alberti

The conventional investor’s target is to buy low and sell high. The short-selling investment strategy is reversed; the investor buys high and sells low.

As an example, if you believe that the XYZ company’s stock price, selling for $10.00, is overvalued, you could short XYZ, guessing it’s price will go down.

You call a broker and ask him to short 100 shares of XYZ at $10.00 per share. The broker lends you the shares, borrowing them from his firm’s own inventory or other sources, and sells them receiving $1,000 in proceeds that is held by the brokerage to secure the loan.

Assuming that in the upcoming months XYZ drifts down to $5.00 per share, at that point, you buy 100 shares for $500.00 to replace the borrowed shares. The $500.00 profit is the difference between the sale price $1,000, and the cost of purchasing stock to replace the borrowed shares.

What happens if you misjudged XYZ and the stock’s price climbs to $15.00? You’ll probably decide that it’s time to limit your exposure and buy 100 shares for $1,500 to pay back the broker. Your investment mistake would cost you $500.00. In both cases you still would need to pay the brokerage fees.

We do not believe in shorting, simply because of the risk exposure.

Example: In a worst case scenario, if you had invested $1,000 conventionally as described above, and this company went out of business, you would lose your $1,000 investment. This is the maximum loss you could endure.

On the other hand, if you had used the short-selling strategy, made a wrong decision, and the price of the XYZ Company stock went up, and for whatever reason continued to go up, your loss would be unlimited. Many companies today are being bought up and taken over without any prior notice to investors because of the opportunity they present to the parent company. Many times the stock prices are bid up 30 to 50 percent almost instantly. This could cause a loss to the investor of three to five times, or more, the original investment.

We at PCI do not short any stocks simply because of the high risk placed upon your account. It doesn’t make a lot of sense to me to invest in something where the potential loss is significantly more than the opportunity to succeed. We say this often, but perhaps never often enough: We structure every portfolio to meet the individual client’s objective with a strategy of buying undervalued companies with outstanding growth potential. These stocks are chosen after many long hours of research by our advisory staff. We also purchase the same stocks for our family, our friends, and ourselves.

Information has been obtained from sources deemed to be reliable. Pearson Capital, Inc. makes no guarantee as to the accuracy or completeness of this data. Information is provided for informational purposes only, and Pearson Capital, Inc. shall not be liable for any errors or omissions, or for any actions taken in reliance thereon.

50 Years Of Investment Experience

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