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Rekenthaler Report

Reader Responses

Energy, crises, and strategic beta.

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Slippery Details
This column is a weekend extra: some reader comments that I have not been able to work into my articles.

On March 1, I tepidly praised energy stocks. That column fretted about their uncertainties, with the central thesis being that commodity prices are harder to predict than the direction of the general economy, and thus energy stocks were not a (relatively) obvious buy, as the overall stock market had been in 2009. However, because energy companies had become so downtrodden that almost any news was likely to be an improvement, I was considering a "nibble."

An energy executive concurred that a commodity-price recovery was far from sure, but argued against my example of Kinder Morgan. He wrote:

Commodity prices like crude oil don’t have to have a cyclical recovery. The ‘lower for longer’ case seems plausible given that supply is overwhelming demand, and no one besides Lower 48 producers is cutting production in response ( and we are, as the Saudis like to point out, high cost producers, so our cuts don’t necessarily affect price.

What you don’t explore, however, is whether the correlation between crude oil prices and midstream stocks like Kinder Morgan makes sense. I realize that the risk to midstream cash flows underlying master limited partnership yields was not the focus of your article, but in that case I wonder whether Kinder Morgan is really your best example, as opposed to, say, oil services companies like Halliburton or Baker Hughes.

Well, here's the thing. While in theory Kinder Morgan is relatively sheltered from oil-price changes, as it is paid on transport fees rather than commodity quotes, in practice it has been pounded just as severely as have the purer oil plays. In the nine months from summer 2015 through February its stock price dropped almost 70%, from $44 to $14 per share. So, why not? If oil rebounds, presumably KMI will, too. If oil stays low, KMI’s stock price might languish, but the company should remain in business.

I think I just talked myself into making that trade.

The Opportunity That Wasn't
Bob Gefvert had a different objection:

In your latest column you portray the financial meltdown of 2008-09 as a standard recession and therefore an investment opportunity. It was anything but that. We had the money-center banks failing, TARP, and incessant talk of 'Black Swan' events in the financial media. Friends of mine, small retail investors, were scared out of their wits by the financial-media doomsday machine.

Fair enough. The column glided through that section, as it was not the main argument. To clarify: In December 2008, the blood truly was running in the streets. (Well, not truly, that is a metaphor, but you know what I mean.) Even the eternal optimist Warren Buffett fretted over the possibility of financial collapse. The media machine was correct in expressing panic at that time. In no way, shape, or form was that a standard recession investment opportunity. Nor did I wish to put my cash to work.

However, by mid-to-late 2009 the financial system was recovering, albeit shakily, and the bottom was in sight. That was indeed an investment opportunity, and not just in hindsight. I did invest some money then, as did several of my friends. Yes, the media remained in full distress, giving the impression that the economy remained on the precipice, but that was not so. The headlines obscured the reality.

Bob continues:

I don't think we've fully recovered as a nation from those events. It is not the only thing but it contributes to the general angst when all the standard economic indicators say that we've recovered from that recession.

Agreed. From the late '80s until 2008, stock-market drops were typically viewed as buying opportunities. That auto-optimism is gone--for professional as well as retail investors.

Three Strikes
About "Me Active, You Index," which took a mostly favorable view of academics' habit of preaching the virtues of indexing while investing actively, but which was less complimentary of Myron Scholes' work with Long-Term Capital Management, Michael Falk writes:

Long-Term Capital Management had tremendous success until it went "poof" due to an exogenous, one-time event. Yes, they horribly impaired capital, but does one bad decision mean they weren't talented? Nope, just careless, as you pointed out; too much ego led to too much leverage. Later, John Meriwether [another partner at Long-Term Capital Management] began another fund – he "learned his lesson about leverage" – and blew up again.

Meriwether's second fund avoided the complete collapse suffered by Long-Term Capital, but a 44% from peak to trough during the 2008 financial crisis wasn't the "hedge" that his hedge-fund investors sought, and he was forced to close up shop. A year later, Meriwether had the cheek to open a third fund, but unsurprisingly that had trouble gathering assets. Recently, he put money into a firm that sells hedge funds to Chinese buyers. That sounds like a promising customer base.

Old Book, New Cover
Finally, Todd Johnston punctures"Why Strategic Beta is Here to Stay." Writes Johnston:

Jacobs and Levy have been managing this way for decades. Factor investing is really nothing new.

True enough. Whether the approach is called factor investing, smart beta, strategic beta, or even "smart alpha" (the managers' own preference), Jacobs and Levy have practiced it in a big way for three decades now. The mutual-fund company Dimensional Fund Advisors uses fewer measures than do Jacobs and Levy, but is older yet, having begun in 1981. Owning securities that offer exposure to certain investment attributes (examples: small market capitalization, low price/book value, high stock-price momentum) is not a new idea.

Assembling them via passively managed exchanged-traded funds is, however. That is what I intended to convey in the column. There aren't many new investment ideas under the sun, but there are genuinely new investment packages, and strategic-beta ETFs are one of them.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.