An Inadequate SNaC: Two Out of Three Isn’t Enough

OK, here’s one of my dark secrets. On my commute from Dover, New Hampshire, where I live, to Cabot’s offices in Salem, Massachusetts, I sometimes listen to National Public Radio’s “Morning Edition.”

I used to listen all the time, but having discovered the joy of listening to books on CDs from my local library, I’ve cut back to just often enough to reassure myself that peace hasn’t broken out in the Middle East and that the global economy, environment and culture are all still going to hell at high speed. I need to be able to count on some constants in a changing universe.

But a story on the morning of April 3 really caught my attention. It was an interview with David Swensen, who has managed the endowment for Yale University for more than 20 years. Swensen booked a 28% return in 2007, raking in an additional $5 billion for the endowment, and adding luster to his long-term average gain of 16.8% a year during the last two decades. With the Yale endowment now valued at $22 billion, he sounds like a man who knows what he’s talking about.

On “Morning Edition,” what he was talking about was diversified long-term investing with periodic rebalancing. His method is to put 30% of his money into U.S. equities, 20% into real estate, 15% each into Treasuries, developed ex-U.S. equities and inflation-protected Treasuries and the remaining 5% into emerging markets equities. All of these are accessed by way of index funds, which have lower fees.

Every time U.S. equities (for instance) go up, he sells enough to restore their 30% allocation. If they fall, he buys more. Sometimes he does this several times a day.

Mr. Swensen sounds like a very smart, very nice guy and I think it’s admirable that he is turning down the tens of millions of dollars he could command as a hedge fund manager to serve his alma mater.

Yet, I’m dissatisfied with his prescription for the long-term financial health of the public at large.

I have a couple of quibbles, one large objection and one very personal comment.

Quibble #1
Swensen has 20 analysts working for him and (assuming that he’s following his own prescription for risk-controlled returns) devotes his entire working life to making tiny adjustments to his portfolio’s performance. I can’t argue with his results, but I suspect that he’s putting Yale into a few more exotic investments than he’s letting on.

Quibble #2
Swensen’s employer is a nonprofit institution, so his constant booking of small profits can take place without tax consequences. An ordinary investor, on the other hand, would be hit with a return-sapping tax bill every time a profit was booked.

Large Objection
The Swensen method uses index funds as a way to achieve lower management fees. Assuming that the S&P 500 Index will be a big part of the mix for the U.S. equity component, that means that investors following his advice would have absorbed a 20% decline in the value of that allocation during the latest bear market, translating to a 6% decline in total portfolio value. Even if periodic rebalancing has the portfolio buying more of the Index at a lower price (and thus ultimately recouping the loss in the long term), it’s hard to figure out why a savvy manager would sit through such a decline without taking defensive action. A percentage saved (through fleeing to cash when a bear market is confirmed, for instance) is a percentage earned.

Very Personal Comment
Maybe it’s just me, but does Swensen’s investment method sound like any fun to anybody? In the NPR interview he says that he balances the portfolio himself rather than using automated software because “that would take all the fun out of it.” Maybe being in charge of billions of dollars just burns the what-the-heck spirit out of a person, but I fear that anyone who thinks that that’s fun may have forgotten what the word means.

Swensen (whom I genuinely and deeply admire, don’t get me wrong) advises people to avoid buying individual stocks. I can almost hear his amiable Mid-western voice saying “Ah, jeez, they’re just too risky!” Some people can get enough in the way of thrills doing a good crossword puzzle, too. But for people with slightly higher adrenaline needs (and higher risk tolerance), there’s nothing like an individual stock climbing the charts to get the blood pumping.

Anyway, that’s why I listen to NPR … at least every once in a while.

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Now that I have a little perspective on my trip to China, I thought you might appreciate hearing my China travel tips. There’s nothing earth-shaking here, but it’s straight from the horse’s mouth (and the horse just got back from China).

China Travel Tip #1-Read Before You Go
Some travelers are impressed by China’s wonders without having any historical or cultural context to put them in. Just a little background (like figuring out who the Great Wall was trying to keep out) can make them even better. A quick Web-crawl through a few sites on China’s history (one of the longest in the world) and customs will pay off big-time.

#2-Gear Up for Security
It’s hard to have a good time when you’re worried, and the persistent warnings about pickpockets are worrying. My wife and I like to get to know a place by walking, including into some pretty seedy neighborhoods. We never, repeat, NEVER felt threatened by violence anywhere we went. And the gear we bought to keep nimble hands out of our purses and pockets (jackets with zippable inside pockets for wallets, secure purses, etc.) let us relax and enjoy the crowds without fretting about our wallets or other belongings.

#3-Go Walking
The tendency for many travelers in a country where they don’t understand the language is to get into as large a group of their fellow-countrymen as possible and stay on the rails. Tour groups are very efficient at delivering the sights to you (and also delivering you to the retailers). On the other hand, if nothing unplanned happens to you on a trip to China, you might just as well have stayed home with a National Geographic coffee-table book. The more you leave the tour tracks behind and just walk around, the greater the chance that you will bring back the kind of memories and stories that will last a lifetime.

Wuxi Pharmatech

If you ever look at lists of the top gainers on the various exchanges, you can see some percentage gains that make your mouth water. On Tuesday, I saw a Chinese stock jump more than 40% in one day, and I know that there must be people out there who were tempted to grab some despite the voice of sanity that told them not to.

I’m so sure of this that I’m not even going to tell you what the stock was. It’s not fair to tempt people.

I’ll just say that this 40% jump took place on a volume of exactly 100 shares and that the stock in question trades over-the-counter on the bulletin board service. If there are blue-chips, growth stocks, value stocks and speculative stocks, this one was about two grades below speculative.

I can’t stress enough how important it is to have all potential sources of support for a stock flashing a green light before you invest. I use SNaC as a mnemonic to remind myself that I need to have a stock’s Story, Numbers and Chart all in a row before I consider taking a position.

Here’s how it works with a China stock that I’ve had my eye on since it came public last August. The company is Wuxi Pharmatech (WX), which helps pharmaceutical and biotech companies with research, development and manufacturing. China is a huge market with a growing appetite for Western-style pharmaceuticals, so Wuxi has huge potential for domestic growth as well as serving the U.S. market, which now provides almost 80% of revenues. That’s a good story, which starts the SNaC off right.

Wuxi’s numbers are also impressive, including a 183% jump in earnings in Q4 on a 62% rise in revenues. After-tax profit margins just hit an all-time high of 32.7% and 23 institutional investors have already signed on in less than a year. 2008 earnings estimates are up, giving a positive direction to future results. So the “N” is OK, too.

It’s the “C” that gets WX into trouble. The stock’s chart shows a strong post-IPO blastoff that took the stock from 14 to 46 on good volume. But since that October high, the stock has corrected sharply, falling as low as 18 before recovering to a support level at 21. That’s the kind of chart that might appeal to a fundamental investor, but not to my growth-oriented sensibilities; big investors are clearly in a selling mood.

The perfect growth stock isn’t a “two out of three ain’t bad” kind of proposition. If you can’t get all three, you’re better off in cash, which is where the Cabot China & Emerging Markets Report portfolio has had most of its money since January.

Wuxi looks good on our watch list, but it’s not the kind of balanced SNaC that’s going to tempt us into an early buy.

Editor’s Note: I keep telling people that the only way to get in at the beginning of a market rally is to start preparing before the rally starts. If you’re not preparing to buy before the herd does, you’re going to be either in the middle of the herd or trailing behind. The Cabot China & Emerging Markets Report can give you the buy signal you need well before the herd starts to move. Now is a good time to try a no-risk trial subscription. Click the link below to find out more.


Paul Goodwin
For Cabot Wealth Advisory

P.S. We here at Cabot want to thank our subscribers who offered valuable feedback about Michael Cintolo’s FAQ issue of Cabot Wealth Advisory and who have been contributing to the Cabot Forum. Due to popular demand, we will be offering FAQ issues of Cabot Wealth Advisory more frequently, and there’s a new way to submit questions–the free Cabot Forum. To do this, register a unique username and password for the Forum, which can be found at and then enter your question into the Ask the Editors section. We will check back periodically to see what questions are being asked and many of them will be answered in future issues of Cabot Wealth Advisory. So keep reading to see when your question might appear!


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