Smug Portfolio : January Allocations

The hedge fund model which makes use of the assets and methodology that is the subject of this blog runs as two versions: the active, hedge fund version, and the passive Assets Under Management version. The hedge fund version is for accredited investors only, and uses active management based off a fairly complex trading model I created over the last 2 years. The active model attempts to capture maximum upside while limited volatility and risk. The fees are higher in the active model (but not much), and the historical results (which don't guarantee future performance) is more stable.

The "passive" management model used for individual investor accounts allows non-accreds (less than $1M net worth) - basically, me and everyone I know - to invest in a balanced green portfolio. While it's more volatile than active management, it should act as a way for normal people (aka, everyone) to invest green, get some measure of active management at a minimum of cost, and feel smug. In an effort to be open source about green investing, I will list the passive management positions on a quarterly or biannual basis. See below, with allocations. Note that the allocations listed below are for educational purposes - they are not recommended for everyone, and are based on dated model generated information.

Passive Positions as of January 1, 2008

CRATX CRA Qualified Investment Retail (CRAIX) 11.64%
DBA DB Agricuture ETF 8.79%
DSBFX Domini Social Bond Fund 12.10%
EWM iShares MSCI Malaysia Index ETF 7.61%
FXC CurrencyShares Canadian Dollar Trust ETF 9.29%
FXS CurrencyShares Swedish Krona Trust ETF 9.78%
PAXHX Pax World High Yield A 16.77%
QCLN First Trust NASDAQ Clean Edge ETF 7.49%
SH ProShares Short S&P 500 ETF 7.60%
UDN PowerShares DB USD Index Bearish ETF 8.93%

These allocations have changed, but notice the nice mix of community investments (CRATX), commodities (Agriculture, Currencies), short positions (SH, UDN), and green/SRI. This is based on the Smug Passive model dated 6/23/08 3:25PM.

For more detailed look at two of the funds listed above, see Smug posts here and here. For an explanation about how currency and indexes (Malaysia, Sweden, Canada, etc) play a part in the model, read the post about it here.

Smug Contributions

FYI, check out the Smug contribution to Work.com's "How-to" guides - our quick and dirty guide to investing in green assets.

See it here.

Local Vs. Green: Cage Match

There is a lot of barking about green energy, sustainable lifestyles, and all things eco. In the end though, it's far more important to be local than green. Supporting local economies, especially agriculture, would save far more energy than any green solution. The cost of travel for a tomato out of season versus buying tomatoes locally during the season and canning them yourself is obvious, but even the externalities are obvious: more pollution, greater infrastructure strain, more exposure to disease (like the recent salmonella scare) when not buying local.

As an investor, I like the idea of having a small portion of my stock allocation in "local only" companies. Even when it means I own some volatile small cap stocks, it gives you a proxy vote and allows you to help shape your local community as a shareholder. Plus, you have a local knowledge of the companies you invest in: you may have friends that work there, you can see their expansions (or retractions), you know their community involvement... it's like rooting for a sports team. Investing locally is VERY HARD, takes a lot of research, and can be a money losing proposal - especially in tiny tiny markets or states. But there's no reason "local" can't be expanded to a more regional presence (ie, a Rhode Island native investing in Connecticut and Massachusetts companies as well). For more info on local investing, check this awesome listing on PBS's Nightly Business Report website.

On a macro level, you may not be able to invest locally quite the same way, but you can at least try the CRA Qualified Investment Fund:

Ticker: CRATX
Inception: March 1, 2007 (officially, but CRA Shares have longer track record)
Asset Type: Mutual Fund - Bonds
Markets: Domestic
Smug Category: Bond
Included in Smug Asset Pool?: Yes
Returns:

YTD	-0.23%
1 year	5.47%

Min Investment: $2,500
Min Retirement Investment: $2,500
Minimum Additional: $1,000
Sales Load:
$2,500 to $24,999.99: 0.00% of offering price
$25,000 to $99,999.99: 0.00% of offering price
$100,000 or more: 0.00% of offering price

Management Fees: 0.40% for 2007
12b-1 Fees: 0.25%
Other fees: 0.31%
Total Annual Fee: 0.96% for 2007

Another no-load no-redemption-fee fund, CRA fund actually has a 7+ year track record, but they changed their name and ticker last year, hence the shortened record. CRATX invests entirely in debt that qualifies for the Community Reinvestment Act of 1977. Now, the CR Act has its detractors, and one could even argue that it helped perpetuate (some say "caused, which in my opinion is ridiculous) the subprime issue. In the end, CRA does a good job (if not bureaucratic job) of building housing in local communities for those who need it. CRA detractors usually forget that it's not the individuals to whom loans are made at fault, it's the securitization of loans, poor rating system, and Wall Street greed that caused subprime. But why take responsibility when you can pass the buck to poor folks?

As debt funds go, CRATX offers a good deal of leg on its income at 4.25% SEC yield, and they have some really nice details about the effect the fund has on local communities (see the charts in the PDF): 140,000 affordable rental units, 4,660 mortgages, $27.3M in affordable healthcare, $121.4M in community redevelopment, etc.

So feel smug and give it a look - another nice compliment to your socially responsible, sustainable portfolio. As always, see my disclaimer to the right of the page.

Not Quite Green Income

One of the basic things I learned in the non traded REIT (real estate) market is: it's all about the yield. Or at least it used to be before subprime. Now there's a question of credit and resale value. But, as a risk averse investor, I would rather take a stable 6% a year with virtually no volatility than a 10% return with moderate volatility. In my hedge fund, I spend all day watching volatility (or, at least, the model does), measuring vol, and scoring potential vol before investing. Most individuals don't have the tools, time, information, or understanding to measure vol at a constant basis, and that means it may be worth it to not take the risk. While green income doesn't yet exist (though, it's on it's way), there are responsible ways to invest in income vehicles - Pax World High Yield is one example

Ticker: PAXHX
Inception: October 8, 1999
Asset Type: Mutual Fund - Bond
Markets: Global
Smug Category: Bond
Included in Smug Asset Pool?: Yes
Returns:

YTD	1.67%
1 year	2.75%
3 year annualized	6.82%
5 year annualized	7.10%

Min Investment: $250
Min Retirement Investment: $250
Minimum Additional: $50 automatic investment, $250 otherwise
Sales Load:
$2,500 to $24,999.99: 0.00% of offering price
$25,000 to $99,999.99: 0.00% of offering price
$100,000 or more: 0.00% of offering price

Management Fees: 0.83% for 2007
12b-1 Fees: 0.25%
Other fees: 0.71%
Expense Waivers: -0.78%
Total Annual Fee: 1.01% for 2007

Pax, as a company, has several funds I like, including the Women's Equity Fund (formerly a separate entity, bought out last year by Pax) and the brand new-ish Global Green Fund. However, for income and stability, there aren't many funds like Pax High Yield with a commitment to socially responsible and sustainable investing. Interestingly, and I think calculatingly, Pax chooses to minimize it's emphasis on the socially responsible and sustainable message in their prospectus, but it's nonetheless a part of the company ethos. On the website are large sections devoted to community investing, responsible shareholder voting, and sustainable investing in general.

In terms of performance, PAXHX is currently yielding a hefty 6.8% and pays on a monthly basis. That's pretty attractive for the DIYer considering it's a no load fund (despite some high management fees). It's currently 25% or so globally allocated to defray some of the domestic risk, and is currently valued below it's year average as it (along with everything else) saw a dip last October. Pax as a company is definitely worth a look, and the High Yield Fund is a good place to start.

PAXHX is currently in my asset pool, and in the interests of disclosure, and I currently own shares personally. PLEASE READ THE PROSPECTUS BEFORE INVESTING. Though I may own and use this asset in my portfolios, it may not be the correct fund for your individual situation, so this post is by no means a recommendation that you purchase. Please read the prospectus in full before choosing to invest.

Changing Tack *

So I'm going to change the tact of this blog a bit and focus more on the asset pool. I'll still go over my start up process from time to time, but I think the more important information is how a retail investor can invest responsibly. I'll focus primarily on mutual funds and ETFs, since it is my belief that individual stocks is, for the most part, playing darts with money. Mutual funds and ETFs spread out the risk and take more "sector" type positions, and I am as risk averse as they come.

So, in that vein, my bread and butter "green" fund is one of the longest running green energy mutual funds in the country - the New Alternatives Fund (MUTF: NALFX). New Alternatives has a long track record, which many investors swear by. In my opinion, their true strength isn't their track record (which is excellent), but their innovation in investing green literally decades before anyone else thought to. Here's the rundown and the fine print:

Ticker: NALFX
Inception: September 3, 1982
Asset Type: Mutual Fund - Equities
Markets: Global
Smug Category: Total Green
Included in Smug Asset Pool?: Yes
Returns:

YTD	-5.06%
1 year	1.71%
3 year annualized	20.48%
5 year annualized	18.90%

Min Investment: $2,500
Min Retirement Investment: $2,000
Minimum Additional: $50 automatic investment, $250 otherwise
Sales Load:
$2,500 to $24,999.99: 4.75% of offering price
$25,000 to $99,999.99: 3.85% of offering price
$100,000 or more: 2.91% of offering price

Management Fees: 0.53% for 2007 - based on AUM.
12b-1 Fees: None
Other fees: 0.42%
Total Annual Fee: 0.95% for 2007.

All in all, the fine print is not too bad. However, like most small and mid cap mutual funds, New Alternatives will have some risk attached, as it tracks the market fairly closely. It has an over 20% standard deviation for it's 10 year track record, which is right in line with the S&P. When I spoke to them about their management strategies, it was clearly a mish mash of technical and "subjective factors" (which is code for "gut"). My big takeaway when doing my due diligence was this: if New Alternatives has historically more or less tracked the market, and they employed industry standard investment strategies, why would I need to invest irresponsibly to get results?

The argument against green and socially responsible investing has been that you give up profit since you limit your asset pool. If that were true, shouldn't a majority of global mid and small cap funds outperform New Alternatives and others like it? Then why isn't it true? Ultimately, when given the choice between a basic small or mid cap mutual fund that invests "irresponsibly" and a fund that invests with sustainable energy as its focus, if they both perform similarly, why not be responsible?

Such is not to say that all managers are created equal, but if the historical returns are the same, it can often come down to combination of investment style and intangibles (the "I like Joe in investor relations" argument).

As the elder states(wo)men of green energy investing, New Alternatives is definitely worth a look. Their asset pool is pretty specifically defined in the prospectus as investing in solar, wind, hydro, geothermal, biomass, fuel cells, hydrogen, and energy conservation/enabling technologies. That's a lot of tech in there, with some recycling thrown in, so expect some decent volatility. In my opinion, the little things can be as telling as the overall investment strategies. For instance, New Alternatives send out quarterly reports and paperwork on recycled and post consumer paper. The reports are typically one color simple text reports, minimizing the "flare" and substituting well thought out, substantive reports. It's a clear sign that, despite having over $300M under management, they haven't lost their grassroots appeal. It is definitely worth a look.

NALFX is currently in my asset pool, and in the interests of disclosure, and I currently own shares personally. PLEASE READ THE PROSPECTUS BEFORE INVESTING. Though I may own and use this asset in my portfolios, it may not be the correct fund for your individual situation, so this post is by no means a recommendation that you purchase. Please read the prospectus in full before choosing to invest.


* - Thanks Gregory for being sure I keep my ridiculous malapropisms to myself!

Oh Money Where Art Thou

So my concerns about starting a business, like anyone starting a business, are many. And, like anyone starting a business, the primary concern is money.

I should start by saying that my mission, other than injecting some much needed long term responsibility into investing, is to be the anti-hedge fund. Even look at my name, "Smug Investments LLC" - it's like I'm kicking old white men in the teeth a bit (sorry old white men, no offense!). I want to be as open source as humanly possible. Without sacrificing the ability to make a meager salary, of course. I grew up using open source, hacked, and warez software in the information age. I've used the interweb for 17 years or so, I like that I don't have to pay someone to learn how to fix my bike or file legal documents, since the information is readily available if you are patient in searching and willing to work at it. I think my fund should be similar. No more secretive shenanigans. No more hedge fund implosions and subprime riduculosity (I coined that phrase, of course). Instead, let's talk about what the fund does, why it does it, and how I set it up.

Since open source is as much about freedom of information as it is about community, I want to lay out the fees, mine and the standard, to go through. Anyone into hedge funds knows about 2 and 20, which basically means a 2% annual "management" fee and 20% of new profits taken quarterly. Now, that's a lot of fees. People balk at mutual funds that charge 1.5% in management fees. In fact, a good argument can be made for Vanguard as your sole source of mutual funds, since they are either low cost or free of fees entirely. In fact, DIYers should be using Vanguard and a series of ETFs, and screw professional management all together for the most part. You'll understand why when you see the fee chart below. The fees listed are actual fees from a fund I've sold before. They do not include interest or dividend income (which is really just a way to make fees look lower):

Fee Type	Fee Payee	Annual %
Brokerage Fees	Prime Broker	0.66%
Management Fees	Trading Advisor	1.00%
Management Fees	General Partner	1.10%
Agent Fees	Selling Agents	3.00%
Incentive Fees	Trading Advisor	0.50%
General Partner Fees	General Partner	0.08%
Adminstrative Fees	Service Providers	0.75%
	Total Annual:	7.09%
Incentive fees are 25% of net new profits paid quarterly
"General Partner fees" consist of 1% of profits/losses
per year taken by the General Partner

So let's go over this bit by bit. Firstly, it's obvious that hedge fund companies basically pass along virtually every operational cost they can think of to their investors. These are in the form of "Management" fees (in this case, there are two payees: the General Partner and a Trading Advisor), "Administrative" fees, and "Broker" fees. Administrative fees are often capped by larger funds, anywhere from 0.75% to 0.25% per year. It still amounts to the same thing: they charge you for legal and accounting. The same is true of Broker fees, since the clearing broker needs to make their cut - trades don't come free after all. The problem with the Administrative and Broker fees is that the investor has no say. You cannot negotiate, you cannot pass go. And what you don't see, you don't know. For instance, many larger funds get kickbacks from brokers and legal/accounting firms for keeping the business with them. The accounting is often not that difficult, the legal is "ongoing", but minimal in reality, and the broker basically does what it does all day anyway. So, even though the offering memorandum names law, accounting, and broker companies, it doesn't say a peep about any conflict of interests with the fund. In fact, I have been told by a lawyer that I shouldn't try to do anything myself and should hire big name firms to look "credible." He said, "once you have investors, you just pass the cost to them anyway."

The "Management" fees are some of the more egregious. In this case, the management fee is split between a Trading Adviser (often a third party to the fund) and the General Partner (the fund "manager"). They charge 2.1% per year no matter what. I suppose your consolation should be that if you lose all your money, they make nothing. Not that this is anything new, if you want "professional management" at a separate accounts like the institutions, it'll cost you almost the same amount. So, there is a conflict of interest that becomes apparent in this fee - what is the incentive to be profitable if you're making money anyway? Doesn't that incentivise funds to gather assets rather than make new profits? Short answer, yes. Long answer, yes.

My favorite ridiculously stupid fee is the "Agent" fee. I was an agent, let me tell you what we did. We had Joe Investor on the phone and said, "Hey Joe, check out this fund. They're low correlation with good historical returns. We recommend it. We'll send you the paperwork." Now, Joe trusts us, so he says, "Sure. What will it cost?" We'd laugh and say, "There's enough fees to choke a horse! But returns are net of fees, just the cost of doing business." And inevitably, because they trust us, they say, "Sure! Sign me up!" That is what we do for our 2% per annum of your hard earned dollars. Of course, if Joe has a problem, we have to deal with it, but is that really worth 2%? To put 2% per year in perspective, that's $2K for every $100K. So if you invest $100K on Jan 1, and it's worth $110K on Dec 31, a 10% return, we've been getting about $2K just for signing you up. That doesn't include compounding, since agent fees are paid monthly in most cases. It just goes to show that not only are the funds ripping you off, but so is your broker. ALWAYS ask what's in it for the broker, and you'll find they're getting paid handsomely.

Now we're on to the "Incentive" fees. Now, here's a fee I can agree with in principal. Basically, the fund is paid 20% of new net profits only on a quarterly basis. Hypothetically, this aligns the fund and the investor perfectly. It basically says, "if you don't profit, we don't profit." You'll not that there are virtually zero funds that are purely incentive fee based, since they all realize one thing: we can and will lose money. And if they lose money, they make nothing. So they cover all their bases and charge for everything just in case they implode.

So what's a fund to do? How do I make money, be open source, and align my interests with the investor? I'm proposing a lower fee structure for one thing (see below for my proposal).

Fees	$s (Ann)	% (Ann)
Management Fee	$7.50	0.75%
Brokerage Fee	$7.50	0.75%
Custodian Fee	$2.50	0.25%
Administrative Fee	$3.30	0.33%
Performance Fee*	$2.79	25.00%

And I'm going to use local services only for the administrative if I can. But ultimately, I have to charge for what I'm doing until I'm sustainable. But I will say this: I'm making my first investors free of charge for life. I haven't decided how much, maybe $1M, maybe $2M... but it will be free of all this nonsense. And I will extend the same courtesy to any community based non profit that works in any local community if they demonstrate they are committed to local sustainability or green causes. It's only fair, right?