The last two weeks have seen vast changes to the financial industry in this country. These are so much in the news that there is little point in reiterating the lengthening list of investment banks, thrifts, and insurers that have failed, been bought, seized, or bailed out by the Treasury or the Fed. Because so many enormous, and venerable, institutions have been affected, investors may naturally worry, not just about the state of the markets and the economy, but about the safety of their financial assets. Indeed, we have received a few telephone calls from clients concerned about this issue. We therefore thought it would be appropriate to clarify the asset protection offered to our clients by their custodians (SCLC is not itself a custodian, and thus has no client assets to protect).

Recent market volatility, triggered by unexpected events such as the Bank of America takeover of Merrill Lynch, the bankruptcy filing by Lehman Brothers, and Federal support for insurer AIG, has led to increased press coverage of events on Wall Street. While this increased coverage is natural, much of it is misguided, thus unhelpful, and may exacerbate investor worries. Consider the following dialogue from a TV news program about the market “chaos” of the last few days:

Reporter: Do you see a bottom to this market?
Guru: No, the bottom is not yet in sight.

Reporter: How long will this market turmoil last?

Firm principal Jon Chambers was quoted extensively in an article that appeared in the Bureau of National Affairs (“BNA”) Daily Report for Executives on Monday February 11, 2008. The article, “Labor Effort to Enhance Plan Fees Disclosure Draws Mixed Response” describes a series of Department of Labor (“DOL”) initiatives to improve the quality of fee disclosure in the 401(k) marketplace. Mr. Chambers describes how the DOL initiatives will help improve existing practices, but argues that Congressional action is still required to address problems relating bundled fees and intra-company revenue transfers.

During the last several weeks, world equity markets have coupled and, in general, have moved downwards. Although the magnitude of decline is well within the expected probability distribution of stock prices, nevertheless, some investors may become disconcerted because of a natural human tendency to extrapolate current events into an indefinite future.

One of the basic principles of investing is that the future return on a portfolio of risky assets is a random variable – i.e., not knowable. Over many long planning horizons, under some simplifying assumptions, actual portfolio return converges towards a number that is greater than the risk-free rate available through U.S. Treasuries or bank CDs. Likewise, over a single life’s long-term planning horizon, it is also reasonable to expect that a portfolio of risky assets will outperform a risk-free investment.

Employers not liable for 401(k) losses in target account by Kathleen Pender, San Francisco Chronicle, Sunday, October 28, 2007.

The U.S. Labor Department last week issued final rules designed to get more employees participating and investing more aggressively in their 401(k) plans.

The new rules say that employers can’t be held liable for losses in a 401(k) account if they enroll employees who don’t sign up themselves and direct their contributions into one of three qualified default options: target-date funds, balanced funds and managed accounts.

Jon Chambers, principal at Schultz Collins Lawson Chambers, Inc., testified at a U.S. House of Representatives Committee on Education and Labor hearing concerning 401(k) fees on October 4, 2007. You can also download the text of his testimony.

The main article from the Q2 2007 Investment Quarterly (on optimal size for actively managed funds) was adapted from this much longer and more comprehensive paper by Patrick Collins. It addresses many other issues relating to investment prudence for fund managers.

Without More

Does Size Matter?

The only reason to invest in actively managed funds is to earn alpha: returns greater than those of the market. As active funds accumulate a history of such returns, they naturally attract more and more money. But for various reasons, it turns out that as an active fund grows, it becomes harder and harder to earn alpha. In this quarter’s main article, we explore why that is so, and whether there is such a thing as optimal size for actively managed funds.

The article is adapted from a much longer paper addressing many issues of investment prudence for fiduciaries, written by our own Patrick Collins, and available here.

Our main article this quarter reviews the venerable subject of portfolio diversification. Why is it important to diversify? You’ll know exactly why, by the time you finish reading.

Investment Quarterly Download

Among the issues and questions we intend to address:

• Confronting the “Threshold Limit” in the value of your Portfolio: As credit markets seized up and stock markets incurred steep losses you may have made an ad hoc decision to change the structure of your portfolio. This decision may have been driven by a decline in portfolio value to your threshold limit – i.e., the level at which you are unwilling to incur further losses. Are there wealth management strategies that anticipate this decision, or even set it in motion at a predetermined level?

• Evaluating the impact of the Financial Crisis on your personal circumstances: The recent declines in the stock market have likely changed your position relative to your primary objectives, such as