Friday 28 December 2012

Death By Opinions!

By Barry Ritholtz

Chart via No Brainer Trades
> 
Steve Winiarski of No Brainer Trades brought the above chart to my attention, and its worth spending some time detailing.
“I heard this guy on CNBC . . . well, his opinion is . . . his trades are . . .”
As the chart suggests, these turn out to be amongst the more expensive expressions of opinion that investors have. By definition, if you are relying on other people’s opinions, then you have been making investment decisions based on how these people play to your squishy emotions.
History has shown this to be a an unsuccessful investing process — who manages to touch push your buttons.
If you are relying on someone else’s opinion, then you are not relying on your own research, you are not basing your analysis on data, on history, or on logic. You have no idea whether or not you are making decisions based on high probability outcomes, but the odds are against it.
This is the latest chart in our pantheon of bad decision making . . .




Friday 21 December 2012

Dec 17 Online Accounts and Assets: What happens to these things after you die?


Guest blog by Micheal Carabash
My guess is that, on average, we have at least 20 different online accounts.  At a minimum, this includes e-mail, social networking (e.g. Facebook, Twitter, LinkedIn, Youtube, MySpace, Flickr), entertainment (e.g. iTunes, Second Life, World of Warcraft) and online bank and trading accounts.  But if you also run a business, you probably have other online accounts that could have significant financial value – such as those related to a website or blog, Google Adsense, affiliate programs (e.g. Clickbank), PayPal, or eBay.
But when it comes to death, not many people think about or outline plans concerning their online accounts and assets.  In a survey of 1,006 Canadians 45 and older “among the 36 per cent of those who have included their online properties in their estate plans, nearly two thirds have failed to provide any specific instructions about what should happen to the accounts in the event of death” (BMO Retirement Institute: April 2012).
So what happens to these accounts and assets when you die? 
Ideally, you should have expressed your final wishes concerning these online accounts and assets before you died.  You can certainly gift online assets which have significant financial value and which you both own and are legally capable of transferring in your Will.  But you should not be including usernames and passwords in your Will given that those things may change and an update to your Will would require you to have a legal document called a “Codicil” (which you may not bother doing every time you change your password because of the inconvenience and potential financial cost of preparing and executing a Codicil).  On top of that, you may not want to disclose usernames and passwords in Wills and Codicils because they may become public documents after your death.
Rather, you should identify your online accounts and assets (a digital inventory of sorts) and include usernames and passwords in a private memorandum that is placed alongside your Will.  You can update this memorandum without having to go through any legal formalities and without the risk of it becoming a public document.  Both your Will and this memorandum should be placed in a fireproof box, or in a safety deposit box at the bank, or at a lawyer’s office (again, in a safe place); the person you’ve named as being responsible for taking care of your estate when you die should know where these documents are and have access to them.
Failing to leave behind this vital information could inadvertently lead to some online accounts being terminated for inactivity, while online assets could be frozen or potentially disappear altogether (leaving your beneficiaries empty-handed)!  It can also cause a lot of anguish to loved ones, as they scramble to remove or transfer your digital footprint; in these regards, they may need to turn to a forensic computer expert or the court in order to make any progress.
Now, let’s take a look at how some of these online accounts and assets are / can be dealt with upon death.  You may be surprised to know that not all online accounts and assets are capable of being legally transferred when you die.
iTunes
You may have bought hundreds or even thousands of downloaded songs, videos, eBooks and apps on iTunes.  But Apple’s “Terms of Use” say that you are purchasing a personal license to access (i.e. listen to, watch, transfer onto different devices) the content – but that you do NOT own the copyrights or intellectual property in the content itself.  Furthermore, you’re not allowed to transfer the content to anyone else and you can only use the content on devices which you own or control.  Here’s the relevant part:
You may not rent, lease, lend, sell, transfer, redistribute, or sublicense the Licensed Application and, if you sell your Mac Computer or iOS Device to a third party, you must remove the Licensed Application from the Mac Computer or iOS Device before doing so.
Rumours circulated earlier this year by the U.K.’s Daily Mail that Bruce Willis was considering suing Apply to clarify who owns content downloaded from iTunes.  According to that rumour, Willis wanted to leave his large iTunes collection to his daughters.  While this story was denied by Willis’ wife on Twitter, it still brought light to the issue of whether you can transfer your iTunes account when you die.
Now regardless of what Apple’s Terms of Use say, some people will no doubt find ways to transfer their iTunes library to others when they die.  They may, for example, illegally impersonate an iTunes account holder (in violation of the Apple’s Terms of Use) or copy their iTunes content onto a physical DVD or hard drive and then gift those things to their beneficiaries in their Will or private memorandum.  And, absent a dispute, how would Apple ever find out?
Amazon Kindle eBooks
Amazon Kindle’s Store’s “Terms of Use” say that you are buying “a non-exclusive right to view, use and display such Kindle Content an unlimited number of times, solely on a Kindly…” and that you may not distribute or otherwise assign any rights to the Kindle Content to any third party.  Hence, you would not be legally allowed to transfer this license when you die.  Once again, however, some people will find the way to transfer their eBooks upon death to their beneficiaries; they could, for example, gift their Kindle and its contents to their beneficiaries in their Will or a private memorandum and, so long as that person maintained your account and impersonated you, how would Kindle ever find out?
Online Gaming Characters
Massively multiplayer online games like League of Legends and World of Warcraft allow gamers to acquire and develop characters and items; well it didn’t take long for gamers to realize that they can sell their accounts for real money (I’ve seen prices ranging between $100 and $10,000 for such accounts on buy / sell websites like www.armorybids.com)!  But, once again, a quick look at the League of Legends’ Terms of Use confirms that gamers do not own any of the intellectual property in the game; among other things, gamers also are forbidden from gifting their Account and that doing so may result in suspension or termination (i.e. deletion) of their Account.
Paid Advertising Accounts
Google Adsense, Kontera, Infolinks, Amazon Associates Program and eBay Partner Network are examples of programs that pay website owners to display online ads.  These programs can generate thousands of dollars of money every month for these owners.  Even posting YouTube videos can earn big bucks.  According to Mashable.com, for example, the family behind the viral amateur video “Charlie bit my finger – again” (YouTube’s most viewed amateur video), reportedly earned over $500,000 since that video was posted in 2007.
Google’s Adsense Terms and Conditions say that you cannot transfer your rights under the agreement and that any attempt may result in termination of that agreement; those Terms and Conditions also go on to say that Google Adsense payments are made only to the account holder and may not be transferred or in any manner passed on to a third party unless expressly authorized in writing by Google.  Basically, when you die, if you transfer your website and domain account info to your beneficiaries in a Will, they should be able to set up their own paid advertising accounts to earn what you were previously earning.
E-mail Accounts
Passing on your e-mail account information is important for a number of reasons.  First, other online accounts are generally linked to an e-mail account.  If the executor of your Will (i.e. the person responsible for administering your estate when you die) and your beneficiaries can access your e-mail, they will be able to review, maintain, backup, transfer, or delete your online accounts.  They may also gain access to important documents and conversations; this is particularly important for business-owners who have ongoing relationships with customers, suppliers, partners, employees and other key stakeholders.  To prevent against the loss of business goodwill, passing along e-mail account information as quickly as possible is of utmost importance.
It’s interesting to note that while the content of e-mails belongs to you, internet service providers may not be forthcoming in providing access to that account to your Executor or beneficiaries when you die.
Yahoo!
For example, Yahoo!’s Terms of Service say that, when you die, your Yahoo! account will be deleted:
No Right of Survivorship and Non-Transferability. You agree that your Yahoo! account is non-transferable and any rights to your Yahoo! I.D. or Content within your account terminate upon your death. Upon receipt of a copy of a death certificate, your account may be terminated and all Content permanently deleted.
But in 2005, Yahoo! was ordered by a Michigan Court to release e-mails of deceased U.S. Marine Justin Ellsworth to his father, John Ellsworth.  Yahoo! ended up giving the family a CD containing more than 10,000 pages of materials!
Microsoft and Gmail
Unlike Yahoo!, Microsoft and Gmail are pretty accommodating when it comes to providing others with access to your e-mail accounts after you die.
Microsoft will send the contents of a Hotmail/MSN account (including contacts and emails) on a data DVD after receiving certain documentation from authorized representatives (e.g. your Executor or beneficiaries).  Among other things, the person requesting access will be required to provide personal information, a copy of the death certificate, and details concerning the deceased’s account.  After receiving this information Microsoft will verify this information and then send a DVD with the deceased’s account information.
Gmail accounts can be shut down upon request by the Executors and close family members.  Gmail may also give certain authorized representatives access to the contents of your Gmail account in certain “rare” cases and only after they have met some somewhat stringent tests (e.g. which includes providing personal information and identification to Gmail, a copy of the death certificate,  and an order from a U.S. court).
To avoid these headaches, it may be a good idea to make regular (e.g. monthly, weekly, etc.) backups of your sent and received e-mails.  I do this with Microsoft Outlook.  With proper instructions (again, in a private memorandum that accompanies your Will), a somewhat tech savvy Executor or beneficiaries could locate and import or otherwise access those backups.  If you have a private business email account (i.e. a non hotmail, Yahoo!, G-mail, etc. account), you could leave instructions on how to access the webmail server and your emails (where hopefully they’ve been stored all along).
Remember: if you don’t plan ahead and your e-mail account remains inactive after you die, it may be terminated and the content deleted.  For example, Gmail may terminate your account if it remains inactive for nine (9) months.
Facebook
It’s estimated that about 580,000 Facebook users will die in 2012 in the United States alone (2.89 million will die internationally).
Facebook’s Terms and Conditions say: “You will not transfer your account (including any Page or application you administer) to anyone without first getting our written permission”.  This essentially rules out the ability to transfer your Facebook profile and other content when you die.
That said, Facebook’s policy is to “memorialize” your profile when told of death.  When an account is memorialized, Facebook sets privacy so that only confirmed friends can see the profile or locate it in search. Facebook tries to protect the deceased’s privacy by removing sensitive information such as contact information and status updates. Memorializing an account also prevents anyone from logging into it in the future, while still enabling friends and family to leave posts on the profile Wall in remembrance.  Alternatively, Facebook can delete the profile upon request verified by family members (examples of documentation to be provided include: birth certificate, death certificate, certificate from the court establishing that the person making the request is the Executor of the estate, etc.).
Twitter
Twitter says that when you sign up it “gives you a personal, worldwide, royalty-free, non-assignable and non-exclusive license to use the software”, which again means that an account cannot be transferred.   Twitter also states that they are “are unable to provide login information for the account to anyone regardless of his or her relationship to the deceased”.
While the idea of transferring and keeping active a personal Twitter account active seems odd (why would anyone log into your personal account after death and keep tweeting updates?), you would probably want to transfer a business-related twitter account upon your death – particularly if that account had accumulated a large following.    But if the Twitter account is left inactive, it may eventually be deactivated.  Twitter also has a policy that allows certain authorized persons to inform Twitter of your death to deactivate the account.  It seems unlikely it would pursue an individual for logging into a relative’s account after their death, but there are inactivity rules. Your account will not stay around forever if nothing is happening with it.
LinkedIn
LinkedIn has a simple “Verification of Death” form which can be completed and submitted to LinkedIn to close a deceased’s LinkedIn account.  The form can be submitted online or via fax.  Among other things, the person submitting the form will need to know the deceased account holder’s most recent place of employment.  It’s a pretty simple form that does not require a death certificate for processing.
Alternatively, as per LinkedIn’s “Privacy Policy”, if LinkedIn learns that a user has died, it may memorialize the User’s account.  This will involve restricting profile access, removing messaging functionality and closing the account if they receive a formal request from the User’s next of kin or other proper legal request to do so.
GoDaddy
You may be using GoDaddy to host a business-related website or blog (which generally includes having a registered domain name and subscribing to website hosting services).  Before your domain name or subscription services expire, GoDaddy will send renewal reminders to you via e-mail.  If you haven’t left instructions on how to access and deal with your GoDaddy account in your private memorandum and if your e-mail account is inaccessible or de-activated after you die, then your website or blog could go offline for good.  This could be disastrous if your website makes money and contains vital intellectual property and client information.  Once your domain expires, it could be registered by anyone for a few dollars.
eBay
eBay’s Terms of Use say that you will not “transfer your eBay account (including Feedback) and user ID to another party without our consent”.  This effectively rules out trying to transfer your eBay account to another person when you die.  If provided a death certificate, eBay will close an account rather than transfer ownership.  If it is not notified of the death, sales which happen after death would need to be disputed if the items were not delivered as a result of the deceased’s death (and the relatives not having access to the eBay account to understand what needed to be done to honour the sale).
PayPal
PayPal allows an Executor to close a deceased’s account.  The Executor will be required to fax a cover page that states that the account holder is dead and that the Executor wishes to close the PayPal account.  Supporting documentation – such as a copy of the death certificate, Will or legal documentation that provides the information regarding the Executor, and a copy of a photo identification of the Executor – must also be submitted to PayPal.  Once the account is closed, if there are any funds in the PayPal account, the Executor will receive a cheque issued in the account holder’s name.
Final Thoughts
As there are no set rules governing how various internet service providers death with your online account and assets upon death, it’s imperative that you be proactive in itemizing and providing instructions on how to access these via a private memorandum that is kept alongside your Will.  If you simply want some of your accounts to be left untouched and shut down, you should provide these instructions in your Will or private memorandum.  Interestingly, a recent study by webhosting company Rackspace (in association with the University of London) revealed that 11 per cent of Britons had either left passwords to their digital treasures in their Will or were at least planning to do so.
While some of your online accounts may have sentimental value that you want your loved ones to have, other online assets may have real financial value.  Case in point, in 2011 the total value of online assets in Britain was estimated at 2.3-billion pounds, while in the U.S. it was $2.9-billion.
To help organize your online accounts and assets, you might want to consider using an online storage facility. A quick look on the Internet revealed a number of  service providers (predominantly in the US and the UK) such as Legacy Locker, Asset Lock, Cirrus Digital Legacy Services, Entrustet, I-Tomb, and My Digital Executor which offer to securely store your usernames and passwords for your online accounts and also facilitate digital estate planning, posthumous e-mails, and online memorials.
Micheal Carabash

Tuesday 18 December 2012

Avoiding the Next Enron!

Canadian MoneySaver
AVOIDING THE NEXT ENRON
It is likely that you or someone close to you has been adversely affected by well known frauds such as Enron, Bre-X or the more recent Sino-Forest. As an investor, hearing these names is enough to make you cringe and debate cashing out of the markets totally. Companies such as the ones noted above were large scale frauds that lost investors, institutional and retail alike, significant sums of money. These organizations were able to deceive investors through ‘creative’ accounting, complicated business structures and flat-out lying. Situations such as these can be tough to avoid but there are some tips and tools that can help to point out warning signs to investors before they make their investment decision:
Guest blog by Canadian MoneySaver on Sitka Management website!
Click Here to read more!

Saturday 15 December 2012

Financial Advisers

Article that we found in the Globe and Mail:

It's time we made financial advisers live up to that title.


ROB CARRICK
The Globe and Mail
Published Wednesday, Nov. 28 2012, 7:52 PM EST
One of the phoniest words in finance is adviser.
Adviser. If only. In truth, the term has been devalued to near nothing by people who flog investment products while passing themselves off as providers of advice. What a drag for the advisers who really do provide advice, and all the investors who would really benefit from using them.  

Click here to Read more.
          

Thursday 13 December 2012

QUESTION OF THE WEEK
by RM Group of Richardson GMP
http://dir.richardsongmp.com/the.rmgroup/page_2950


The banks reported their fiscal 2012 results over the past week. How did they do?

When we look back at the fiscal fourth quarter for the Canadian banks which lasted from August to October, a few things stood out in the marketplace that gave us a hint as to what we could expect when bank earnings were released. First, there wasn’t much change in the retail environment, and if anything, investors may have expected this business segment to decline slightly across the board as the housing market and Canadian economy both slowed. Second, equity markets performed well during those three months, so investors could infer that capital market and wealth management activity improved as asset levels, fees and commissions should have seen some support. Finally, there was no significant financial event, either domestic or global, that would lead investors to be worried about the ongoing operations at Canadian financial institutions or the loan portfolios of Canadian banks.
So those were the expectations going into the quarter, and it would appear as though those expectations were realized as retail business segments saw net income growth year-over-year but declines quarter-over-quarter, wealth management businesses saw growth in assets and revenues, and capital market businesses were either stabilized or helped by an improved market environment. As such, most bank earnings for Q4/12 were relatively in line with expectations and stock prices have not moved a great deal when compared to where they were before their results were released. Simply put, it was somewhat of a boring quarter for the Canadian banks, but in this case boring is good! Any concerns related to the quality of earnings likely focused on loan loss increases and lower than usual tax rates, but we prefer not to make a big deal about this just yet until a trend forms as these data points can vary a fair deal from quarter to quarter. Capital levels at the banks remain stable and while National Bank was the only bank of the big six to increase its dividend as expected, payout ratios amongst the other five are at a level where many could move again to raise the dividend and repeat the semi-annual dividend increase trend that existed prior to the 2008 financial crisis. Overall, we’d say the results for the banks as a whole were good going into fiscal 2013.

Tuesday 11 December 2012

'Best Buys' from leading analysts.

Canadian MoneySaver
As seen in Investor's Digest,
November 16, 2012.  vol 44, no 21

'Best Buys' from leading analysts.
An interview with Peter Hodson, CFA.

Peter Hodson, chartered financial analyst, needs no introduction, having been a long-time contributor to this publication while working for major Canadian financial institutions....He doesn't spend much time analyzing the economy.  Instead, he concentrates on individual companies, particularly on their earnings...  
To read further, please Click Here.

Wednesday 5 December 2012

You’ve got Choices!

You’ve got $100,000 burning a hole in your jeans. You’ve got choices. You will either buy a brand, spanking new Audi R8 (the super-sexy Audi!) or you will buy a basket of Canadian stocks. (OK, $100K won’t quite get you into an R8, but we can dream, can’t we?)

It’s Canada, so your choices among the bigger-cap stocks are somewhat limited, but you know you want to be represented in four key sectors: financials, telecoms, energy/resources and metals/mining. You’re think of buying four stocks, plopping $25K into each of them and then sitting back to wait for the upside fireworks.

Here’s a tip: Don’t. Don’t buy just four stocks from those four key sectors – buy 12 of them, three from each sector.

Here’s why: If you buy one stock from each sector, you may very well have achieved a minor measure of equities diversification and you may feel as though your equities investing assets are reasonably allocated. And yes, you may, to a degree, have mitigated the so-called “sector risk,” given that you are represented in four key sectors of the Canadian economy.

But here is what you haven’t done: You haven’t done anything to alleviate the “stock risk” part of that equation. You have placed just four eggs into your stock basket – and any one of them could pull a Humpty Dumpty at any time and without any warning. Your four eggs in a basket might just become a sloppy stock omelette!

Here’s an example to make the point: Investors who have had all their eggs in a major global insurer such as Manulife for the past few years have taken a brutal beating. Now, Manulife is a respected, well-managed company, but there isn’t a management team in the world that could have saved Manulife from the twin horrors of the 2008 global financial meltdown or the persistence of low interest rates that has taken such a toll on the company’s financial obligations. The $25K that you might have invested in Manulife back in 2008 would be worth something in the order of $8K today. That’s not good, either for you or your portfolio.

Now, let’s say all those Manulife investors had taken a more cautious route with their insurer-earmarked stock holdings. Let’s say they didn’t dump a full $25K into Manulife, but instead, back in 2008 at the stock-price highs, had spread the risk around by adding Great-West Life and Industrial Alliance to the mix, all three stocks in equal measures. 

Today, whereas Manulife stock is selling at less than 33% of its 2008 high, Industrial Alliance is selling at approximately 75% of its 2008 high; Great West Lifeco, for its part, is selling at 67% of its 2008 high. All three are losers, to be sure, but investors who bought equal parts of all three insurers are vastly ahead of those who dumped all their eggs into Manulife’s fragile basket. That’s largely because Industrial Alliance and Great West are more domestically inclined and were therefore less exposed to the wreckage of the global meltdown.

Run a test for yourself with the telecom/communications stocks using, say, BCE, Rogers and Telus, Canada’s three dominant players. Do you want to make a one-stock bet as to which of those three companies will be the long-term winner in the consumer marketplace? Do you want to run the risk of being dead wrong? Or would you rather spread the risk around buying all three – all with attractive dividends and all with the potential for further stock-price gain.

Here’s our view: Buy them all. Collect the healthy dividends. And then sit back and let the future unfold as it inevitably will. In time, you may well find a Humpty Dumpty cracked egg in the basket – chances are, you won’t find three of them. 

Monday 3 December 2012

Call this the Revenge of the Consumer!

Canadian MoneySaver blog, Canadian Moneysaver, magazine, financial magazine, peter hodson, money, stocks, bonds, saving you money, drip's,
Canadian MoneySaver


 Fed up with those persistent, unending, nickel-and-diming charges on your bank’s monthly savings-account statement? Had it up to here with your buck-30-per-litre price at the pump? Can’t take any more of those outrageous $200-a-month, all-in fees for your home phone, Internet and premium high-def TV? And what about you, your kids and your friendly mobile carrier on your smart phones – now, we’re talking serious money!!!

Of course, you’ve had enough! You want that consumers’ revenge – and you want it now! Here’s the easy, smart way: Quit your whining and just buy the doggone stocks of the companies you love to hate.

Think about it: Canadian oils, banks and telcos — along with energy and resources generally – form the lifeblood and much of the heart and soul of the Canadian investment environment. We’re a small nation, and we investors have limited large-cap investment choices if we choose to keep our money within the country.

Run down this short list as an example: Royal Bank. TD. Scotia. BCE. Rogers. Telus. Canadian Oil Sands. All big caps, all major players – and all coming to your door complete with the measure of safety and stability that well-run big caps might typically offer. And all of them, at the very same time, are annoying the devil out of you because they’ve got their hands so deeply into your household’s pockets. (Well, in Canadian Oil Sands’ case, which posts a dividend yield approaching 7%, the hands aren’t directly into your pockets; that’s a more roundabout route that ultimately leads downstream to the refiners and gasoline retailers!)
 
Here’s the deal: You hate these guys for what they do to you personally; you should love them for what they can do for you financially. They all pay dividends, decent divvys in the 3-5% range, double (or much better) than what you can get with a bank GIC. With inflation running around 2%, the dividends from these companies do their part to help keep your portfolio – and your sanity – afloat. And that’s not even considering the prospect for improved corporate earnings performance, the prospect for stock-price capital gains – and the long-term prospect for dividend increases, which would enhance your buy-in yield.

Let’s take just one example, RBC, to make the point: RBC just announced record annual earnings, coming in for fiscal 2012 with earnings well ahead of those achieved in fiscal 2011. RBC pays a dividend of 60 cents per quarter ($2.40 annualized), generating a dividend yield north of 4%. Now, let’s say you had the presence of mind to buy RBC back in the year 2000, when it paid four quarterly dividends totalling 57 cents annualized. Had you bought back then, and simply held the stock, your yield in 2012 would have more than quadrupled over your RBC stock buy-in price. And that’s not even considering that RBC stock is DRIP-able, which means that, if you chose to roll over your quarterly dividends into new stock at presumably discounted prices, your effective yield today would have been even greater. And all of this doesn’t fully consider the degree of RBC’s stock-price appreciation – in 2000 and again in 2006, the bank rewarded its investors with new stock dividends that had the same, salutary effect as a two-for-one stock split. 

We use RBC here only as an example – and not necessarily as a suggestion to run out and buy RBC stock. You could run down the list of the few examples posted here and find a similar pattern of stock-price and dividend-growth appreciation.

The takeaway? As consumers, hate these guys as you inevitably will because they are annoying. As investors, hold them close to your heart, be patient with them, and chances are, over time, they will return your love many times over.


Canadian MoneySaver

Monday 26 November 2012

In portfolios, go big or go home; Who can keep track of 200 positions anyway?

Peter Hodson

Do you ever get frustrated when you do a ton of work on something, and yet never get any actual benefit from the work you've put in? Most people would, which makes it all the more surprising when you realize that many portfolio managers do exactly that, day after day.

Let me explain: Most portfolio managers are a diligent crew, slaving over financial reports, meeting company management, running models, interviewing analysts and so on. It takes a lot of effort to ensure that an investment idea is appropriate for a portfolio, and no PM I know takes the job or their fiduciary responsibility lightly.

That's why it is surprising that, after all that effort, many PMs tread very lightly with their investment ideas, by just buying tiny positions in their investee companies, and having a portfolio of 100 or more names, rather than concentrating on their best investment ideas.

As a result, many portfolio managers take diversification to an extreme level, to their own detriment. Even though many PMs are CFAs as well, many often forget that part in the CFA course that shows that diversification benefits in a fund start to diminish after just 20 or so securities.

Don't just take my word for it -- in The Intelligent Investor, Benjamin Graham said the number of securities needed to diversify was between 10 and 30. Burton Malkiel wrote that 20 stocks would do it, in his classic book, A Random Walk Down Wall Street. But if you went to www.sedar.com

To examine the annual reports of many mutual funds, you might find 100, 200, 300, even 400 individual securities listed in funds. What gives? Are managers so scared of volatility that they excessively dilute the impact of their own research by making only tiny investments in their own ideas? Perhaps these managers have no confidence in their own stock-picking abilities to take larger positions. Perhaps it is easier to keep their jobs that way, by never being wrong -- by default -- on a large position.

I have no idea why, to tell you the truth, as I try and practise the exact opposite approach. I believe that if you like an investment idea enough, and you have done the proper amount of research on it, then you should make it a large position in your portfolio. If you do the right work on an investment idea, then you should be rewarded for it. Big time. In other words, if you don't like something for at least a 2% weighting in your fund, then you probably don't like it much at all. Why buy a half-percent weighting? Who can keep track of 200 positions anyway?

This idea might rile a few feathers, and certainly may go against the commonly held belief that any diversification is good. But it is not. The great Peter Lynch coined the term "diworsification" to highlight how he would avoid companies that diversified their businesses into something they knew nothing about, just for the sake of diversification. Coca-Cola branching off into shrimp farming years ago is the best example of diworsification in action. But diworsification works with mutual funds, too. Managers should, of course, stick to their expertise and avoid the tendency to add positions just for the sake of diversification. Volatility might be reduced, but at the cost of mediocre performance.

In the dot-com era, for example, in order to diversify, almost all the "value" managers decided to add "growth" companies to their portfolio, even though they weren't familiar with the growth style. These value managers wouldbuy companies trading at "only" 20 times revenue. We know how that worked out. The managers that stuck to their investment style survived the dot-com implosion the best.

As a firm believer in concentrated portfolios, whether by individual securities or investment sector, our firm is obviously biased. So again, don't take our word for it: There is a great study, available on our Web site at www.sprott.com, that highlights the benefits of not diversifying an investment portfolio. In the study, titled On the Industry Concentration of Actively Managed Mutual Funds, authors Marcin Kacperczyk, Clemens Sialm and Lu Zheng conclude "on average, more concentrated funds perform better after controlling for risk and style differences using various performance measures. This finding suggests that investment ability is more evident among managers who hold portfolios concentrated in a few industries."

The key point of the study is that, contrary to conventional wisdom, fund managers should not diversify but instead concentrate their portfolios if they believe some industries will outperform the overall market. If a manager believes they have "superior information" (note this is not insider information, but superior knowledge through extra effort and greater understanding), then they should concentrate their portfolios even more.

A radical thought, perhaps, but scanning the list of top performing funds over the past one, five and 10 years will show you that it works. Many of the best funds have either a smaller number of positions, or are extremely concentrated in just a few sectors.

How can this approach work for you? Well, for fund investors, keep it in mind. Have some -- but not too much -- diversification in your fund portfolio. Morningstar. com, for example, has shown that once you own seven mutual funds, adding another will help neither performance nor diversification. Perhaps the best approach might be to have just a few funds whose fund managers hold concentrated positions. If the funds you hold have dissimilar correlation to each other, there's a good chance you'll likely have enough diversification and decent investment performance. 

Peter Hodson,CFA, Editor
Canadian MoneySaver