The Diversification Debate

In addition to the question of how many stocks they should own, another similar question many investors ask is how many funds or asset classes they should own. In a recent Financial Times column, David Stevenson offers some interesting data on the topic, as well as some comments from top strategists.

The “proper answer” to those questions, Stevenson says, is to follow the modern portfolio theory developed by Harry Markowitz, which “suggests that you look at risks and returns, alongside volatility, and then compute something called ‘an efficient frontier’ of different assets, allocated sensibly, in an optimised fashion.” But, he adds, many of the top financial minds in the world — including Markowitz himself — don’t do that. Markowitz actually once said that he regretfully split his portfolio 50/50 between bonds and equities.

“He’s not alone,” Stevenson continues

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Paulson on Financial Buying Binge

After profiting hugely from shorting financial stocks last year as the sector tanked, hedge fund guru John Paulson has been buying up beaten-down financials this summer.

Paulson has bought a stake of about 2% in Citigroup, the New York Post reports, citing sources. “One source said that Paulson sees Citi’s shares trading closer to its book value of $5 to $7 a share, and that he has been scooping up shares in the bank over the past several weeks,” the Post stated, adding that a Paulson spokesperson declined to comment.

Earlier this month, The Wall Street Journal reported that Paulson bought 168 million shares of Bank of America in the second quarter, as well as 14.9 million shares of Capital One Financial Corp., 35 million shares of Regions Financial Corp., and smaller stakes in Fifth Third Bancorp and Goldman Sachs Group. He also made large investments in mining companies that deal with gold and in gold exchange-traded funds, the Journal reported, noting that Paulson had previously said he was bullish on gold.

Beating the Timing Temptation

As Liz Ann Sonders notes in the posting below, a lot of investors are now wondering whether it’s too late to jump into the market, or, for those who have been in the market during the rally, whether it’s time to cash out. As Sonders says, such all or nothing decisions are very dangerous — and The Stingy Investor’s Norm Rothery has laid out some excellent reasons why.

In an article titled “Tempting Temptation” (originally published earlier this summer in Canadian MoneySaver but still quite relevant now), Rothery touches on a number of studies and data sets on market timing — all of which show that trying to jump in and out of the market often leads to major underperformance.

“Even normally level-headed index investors suffer from poor timing,” Rothery writes. “Morningstar.com reports that the Vanguard Total Stock Market Index fund lost 1.59% annually during the 10 years ending April 30, 2009 but index fund investors suffered a 4.04% annual decline. In this case, poor timing reduced returns by 2.45 percentage points annually.”

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Sonders Says We’re in “Coiled Spring” Recovery, Warns Against All or Nothing Bets

Charles Schwab Chief Investment Strategist Liz Ann Sonders tells Fox Business Network that she thinks we’re in the early stages of a “coiled spring” recovery, and says that too many investors are trying to make all-or-nothing calls as they ponder whether to get back into the market right now.

Sonders, who correctly called the start of the recession, says there’s a risk that what we’re seeing now is a “sugar high”. But, she adds, “I think that the better case right now is that there’s going to be a little more sustainability thanks to corporate profitability than a lot of people think. And I think we could see a longer lasting pop here than certainly the pessimists believe.”

Guru Strategy Rating Changes: Dish Network, Under Armour Rising

Each week, I take a look at which stocks my Validea.com Guru Strategy computer models have newfound interest in, and which they have soured on. Here’s a look at some of the stocks that my strategies have upgraded or downgraded today. Among the bigger names on the move: athletic apparel maker Under Armour and gaming company Electronic Arts.

Guru Strategy Rating Changes -- Aug. 26, 2009

They Got It Right in March; What Do They Say Now?

A few weeks ago, we highlighted how Jeremy Grantham — who quite presciently had advised investors to “reinvest when terrified” back in March — is now sounding much more cautious. And, according to The Wall Street Journal, Grantham isn’t the only strategist who correctly called the market’s upturn but is now feeling less optimistic.

“In March, analysts who picked the bottom were a lonely lot,” writes the Journal’s Mark Gongloff. Now, he says, several of those who did get it right “say they aren’t roaring bulls about the long-term outlook, although their views for the next 12 months are split.”

Among them is Grantham’s colleague at GMO, Ben Inker. “The past 12 years have seen two bubbles that were really good for corporate profits,” says Inker, GMO’s director of asset allocation. “Now things are unlikely to be anywhere near as good as people have gotten used to, because we’re not going to have a bubble to help us.”

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Berkowitz: “Great Environment” for Stock-Pickers

Top fund manager Bruce Berkowitz, whose Fairholme Fund has earned about 12% per annum over its 10-year history while the S&P 500 has lost about 3% annualized, says that this is a “great environment for an investor, for a value-based stock picker, security picker”, and that he’s continuing to see a number of bargains in the market even after its recent rise.

Berkowitz, who is something of a contrarian, tells Steve Forbes that his fund remains high on healthcare stocks, despite — or perhaps because of — all the talk of sweeping healthcare reform. “They’re in the high to mid-single digit [price/earnings ratios] with rock solid balance sheets and you really can’t ask for much more,” he says of Fairholme’s healthcare holdings, which include Pfizer, Forest Drugs, Forest Labs, Humana, and WellPoint. “And my question is: Well, if these companies aren’t going to do it … in healthcare, who is going to do it for us?” Berkowitz says it’s a similar story with some defense stocks.

Berkowitz also delves in to the ins and outs of his portfolio management style. One of his key tenets: Keep a focused portfolio. “Once you get much more than 25 securities, you’re going be lucky to, you know, you’ll be approaching the averages,” he said.

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