A number of recent headlines have indicated that there might be hidden risks for investors in Exchange Traded Funds [ETFs]. Indeed, one headline characterized ETFs as ‘Emerging Threat Funds.’

What’s going on? Are these warnings credible, or is this yet another example of sensational headlines designed to lure readers into buying a publication or subscribing to an on-line investment advice service, that upon examination turns out to be unfounded?

We explore this topic in the article below.

Trustees and legal counsel are sometimes confused regarding the extent to which an investment advisory firm will act in a fiduciary capacity when accepting delegation of investment matters. Although the Investment Advisors Act of 1940 provides that the advisor must act as a fiduciary, it is an unwarranted leap of logic to assume that all advisory firms provide conflict-free services at a level of care skill and caution demanded from a fiduciary. Investment Advisory Services Agreements often contain contractual provisions which opt the parties out of the default prudence standards embodied in state Prudent Investor statutes. This places trustees in a true caveat emptor situation.

Investors currently in or approaching retirement are, of course, correct to be concerned whenever their investment wealth decreases. Less money is not a good thing—especially if there are binding constraints on labor income. Without the financial flexibility of a paycheck, the consequences of assuming investment risk are necessarily magnified.

Given the decline in stock values over the previous quarter, I’d like to inform you of a portfolio-survival-blueprint you may wish to consider. The nature and scope of this blueprint form the main topic of my article published in the Wealth Strategies Journal in 2008. The article “Managing Retirement Portfolio Withdrawals in Turbulent Times: Precautionary Savings, Investment Reserves and Mid-Term Adjustments” can be found in the PDF file below.

Investment Quarterly for the 3rd Quarter of 2011 looks back at the behavior of U.S. Treasury Inflation Protected Securities over a period of extraordinarily low inflation. How did TIPS perform over that period, which exhibited none of the problems they were designed to ameliorate?

We also briefly examine the question of whether TIPS are a good barometer of future inflation. Finally, we discuss in greater detail the differences between three different ways to gain exposure to the risk/return characteristics of TIPS: a passive exchange-traded fund, a somewhat active open-end mutual fund, and a very active open-end mutual fund.

Should skilled investors use stop-loss trading strategies or derivative instruments to protect a portfolio during periods of market turbulence? Do such protective strategies work? Are they costless?

During a period of downside turbulence capital markets are likely to become tightly coupled. Investment portfolios become more fragile because negative shocks to world markets propagate through capital markets more quickly and pervasively than during bull market periods. Tight coupling often means that assets with low or negative correlation during normal market conditions suddenly exhibit similar downside return patterns. This, of course, may reduce the effectiveness of portfolio diversification as a risk control strategy during severe market declines.

Although diversification — the inclusion of assets with return patterns that tend not to mimic each other — is the classic method of portfolio risk control, a variety of other risk mitigation techniques are available. Given the sequence of volatile equity market returns from the plunge in the technology-heavy NASDAQ stock exchange in 2000 through the global recession and the recent U.S. & European sovereign debt credit rating downgrades, investors wonder if trading or financial engineering techniques can mitigate declines in portfolio values.

Patrick Collins completes Working Paper entitled: “Investment Basics: Asset Allocation, Diversification and Correlation.”

See the working paper here

An important step in the implementation of investment policy is the acquisition of prudent and suitable investments. Investors choosing to diversify their investment positions both within and across asset classes often select pooled investment vehicles like mutual funds or exchange traded funds. Inevitably they must address the question: “what funds should I buy?”

Each year, SCLC develops an annual fund evaluation report. We refer to this report, somewhat tongue-in-cheek, as the antidote for the Morningstar/Lipper/Money Magazine type of approach that often rates investments as if they were restaurants. The report summarizes our analysis and opinion regarding investments as of December 31st of the previous year. Specific reports detailing individual investment holdings are sent to each client; and, we retain a master list for in-house reference.

Given the magnitude of recent declines in the price of financial assets, commodities, and residential real estate, investors are coping with decisions about how to invest on a go forward basis. Our recent paper (appearing in our Investment Quarterly for Quarter 4, 2008] situates decision making within the context of investor ‘utility,’ where utility measures the investor’s aversion to declines in wealth as well as the investor’s satisfaction with gains in wealth.

For some investors, risk tolerance changes with increases or decreases in their level of wealth. However, many investment policies mandate a constant proportional weighting between stocks and bonds during both bull and bear markets. A fixed investment allocation is usually termed a “Constant Mix” asset management approach. Such an approach is defensible under a variety of commonly held assumptions; and, is often recommended as a reasonable alternative to the risks of market timing. Advisors advocating that investors “stay the course” during perilous market conditions implicitly assume that investors, in general, benefit from a Constant Mix approach.

Warning! Economic disaster is closer than you think.

Why have an investment reserve? The underlying mathematics of compound return indicate that the more volatile the investment, the lower a portfolio’s long-term growth rate, all else equal. An investment that losses 20% in period one needs 25% in period two in order to get back to even. Periods of negative returns not only decrease portfolio value but, if the portfolio is also funding retirement distributions, the distributions take dollars out of the portfolio at the worst possible time. In a nutshell, distributions multiply the bad consequences of negative returns and cap the benefits of positive returns. The Wall Street term for taking money out of portfolios during periods of economic distress is “feeding the bear.”