Investing in Virtue Is Hard When So Few Companies Measure Up

It’s not easy being a socially conscious investor. To see why, look no further than Facebook Inc.

By any reasonable ethical standard, the social media giant doesn’t measure up. The Cambridge Analytica debacle and its aftermath revealed that Facebook is collecting far more information on its users — and even non-users — than it let on. And, as my colleague Shira Ovide pointed out, when CEO Mark Zuckerberg had the opportunity to come clean last week during two days of congressional testimony, he ducked questions about how the company operates.

Facebook’s wily ways appear to be catching up to it. According to a March 21-23 Reuters/Ipsos poll, only 41 percent of Americans “trust Facebook to obey laws that protect their personal information.” An April 8-9 SurveyMonkey/Recode poll askedrespondents which technology company they least trust with their personal information among Amazon, Apple, Facebook, Google, Lyft, Microsoft, Netflix, Tesla, Twitter, Snap and Uber, and 56 percent chose Facebook. The runner-up was Google, with just 5 percent.

Given all the questions surrounding Facebook, investors may be surprised to learn that its stock is commonly held by so-called socially responsible funds, which invest in companies deemed to be good citizens.

The biggest such exchange-traded fund — the iShares MSCI KLD 400 Social ETF, with $1 billion in assets — bills itself as an “exposure to socially responsible U.S. companies” and urges investors to use the fund to “invest based on your personal values.” The fund has a 3.5 percent allocation to Facebook.

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Hedge Funds No Longer Need the Star System

Hedge funds’ brightest lights have fallen on hard times, but don’t shed a tear for the industry just yet.

The list of once-revered-now-humbled hedge fund managers is growing. Alan Fournier is shutting Pennant Capital Management after nearly two decades, acknowledging that “recent returns have been disappointing.” David Einhorn’s main hedge fund at Greenlight Capital was down 14 percent in the first quarter  after a decline of 4.1 percent annually from 2015 to 2017. Pershing Square Capital Management’s Bill Ackman calledhis recent returns “particularly unsatisfactory,” and investors apparently agree. Ackman’s assets under management shrank to $8.2 billion as of March from $18.3 billion in 2015.

Despite the travails of star managers, however, the hedge fund industry is doing fine. The HFRI Fund Weighted Composite Index returned 0.3 percent during the first quarter, compared with a negative 0.8 percent for the S&P 500 Index, including dividends.

Granted, hedge funds haven’t kept pace with the stock market in recent years, but they’ve fared better than many of the stars among them. The HFRI index has returned 4 percent annually from 2015 through March, compared with 10.2 percent for the S&P 500.

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Classic Safe Haven Hides in Plain Sight

Watch volatility spike, and then watch investors scatter for safety. Only this time, they don’t seem to know where to hide.

After years of calm, market turbulence has returned. The annualized daily standard deviation of the S&P 500 Index — a common measure of volatility — has been 18.6 percent from 1928 through March. But the market was much quieter from 2012 through January, with a standard deviation of 12 percent.

That quiet ended abruptly in February. The S&P 500 tumbled 8.5 percent in just five trading days from Feb. 2 to Feb. 8, and its standard deviation has spiked to 23.4 percent since February.

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Users Built Facebook’s Empire, and They Can Crumble It

Facebook’s true value resides in its 2.1 billion users, and investors need to worry about what happens if enough of them decide that free social media isn’t worth the cost.

First,  a disclosure: I’ve never used Facebook. I get that it’s an awesome way to keep in touch with family and friends, meet new people and get a personalized online experience. But I value my privacy, and it’s hard to reconcile that with the fact that Facebook is in the business of selling its users’ information.

And it’s a great business. Facebook generated earnings from continuing operations of $15.9 billion in 2017 on revenue of $40.7 billion, 98 percent of which came from advertising.

If it isn’t already obvious that Facebook is a money-making dynamo, consider how it stacks up with digital ad rival Alphabet Inc., the parent of Google. Facebook’s gross margin was 87 percent last year, and its net income margin was 39 percent. That compares with 59 percent and 11 percent, respectively, for Alphabet.

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Theranos Crackdown Offers Welcome Check on Tech Startup Frenzy

Theranos did no favors for its investors, but it may have unwittingly helped the next generation of innovators.

The Securities and Exchange Commission last week accused the company and its CEO, Elizabeth Holmes, of misleading investors. According to the SEC’s complaint, Theranos lied about the capabilities of its blood-testing technology on its way to raising $700 million from 2013 to 2015.

As my Gadfly colleague Max Nisen rightly pointed out, “the sheer extent and audacity of the fraud perpetrated by Theranos’s leaders separates it from the pack.” But Theranos couldn’t have pulled off its elaborate fraud without the help of two larger forces.

The first is investors’ eagerness to throw money at startups on a scale that not long ago was available only to publicly traded companies. So-called unicorns — startups valued at $1 billion or more — raised $70 billion from 2014 to 2017, including a record $19.6 billion last year, according to financial data company PitchBook. To put that in perspective, that’s roughly three-quarters of the total net flow to all U.S. mutual funds over those four years, according to fund flows compiled by Bloomberg Intelligence.

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Bitcoin Isn’t an Investment Until Buyers Sweat the Fees

If you want to know where cryptocurrencies are in their development, keep an eye on fees.

When a new “investment” comes along, investors are often too busy counting their anticipated bounty to care about cost. Shrewd purveyors predictably seize the opportunity to charge excessive fees. But reality inevitably falls short of investors’ expectations, and the focus eventually turns to how much they’re paying to invest.

That’s a short history of stock investing. Investors had little access to stock market data a century ago. They didn’t have the luxury of knowing, for example, that the S&P 500 Index would generate a real return of 7.1 percent annually from 1926 to 2017, including dividends. Or that the index’s real return would fall short of that long-term average 52 percent of the time over rolling 10-year periods.

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Vanguard Disrupted Active Investing. Now It Could Save It.

Indexing pioneer Vanguard Group may be stock pickers’ last hope.

Investors are increasingly turning their stock picking over to computers. So-called smart beta exchange-traded funds track indexes that replicate traditional styles of active management such as value, quality and momentum. Investors handed $184 billion to smart beta ETFs from 2015 to 2017 while pulling $308 billion from equity mutual funds, according to data compiled by Bloomberg Intelligence.

It’s not surprising. Smart beta ETFs are cheaper, and investors are skeptical that human stock pickers can beat the bots by more than the difference in fees. According to Morningstar data, the average expense ratio for smart beta ETFs is 0.47 percent a year, and the asset-weighted average expense ratio — which accounts for the size of the ETFs — is just 0.26 percent. That compares with 1.13 percent and 0.7 percent, respectively, for actively managed mutual funds.

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China’s Shadow Won’t Eclipse Emerging Markets

China’s parliament begins a two-week legislative session on Monday that is widely expected to clear the way for Xi Jinping to be president for life. As concerned emerging-market investors question what will happen in China, they should remember one thing: China isn’t synonymous with emerging markets.

Investors can be forgiven for conflating the two. Many of them see the developing world through the lens of an emerging-market stock fund, and Chinese companies increasingly dominate those funds.

Consider, for example, that China accounts for 27 percent of the MSCI Emerging Markets Index. That’s 13 percentage points more than South Korea, the second-largest  allocation in the index. It’s also 18 percentage points more than China’s slice of the index a decade ago, when it was fifth behind Brazil, South Korea, Taiwan and Russia.

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High Times for Marijuana Stocks

Marijuana stocks would be the ultimate growth play if investors weren’t already so fired up.

It just got easier for U.S. investors to bet on pot’s big plans. Toronto-based Cronos Group Inc., which invests in medical marijuana producers, on Tuesday became the first marijuana company listed on a major U.S. exchange. Analysts expect its revenue to reach $34 million this year, up from $400,000 in 2016.

Cronos’s debut follows that of ETFMG Alternative Harvest ETF on Dec. 26, the first U.S.-listed marijuana exchange-traded fund. If ETFMG’s popularity is any indication, Cronos will soon be awash with money. Investors have already poured $386 million into the ETF through Tuesday.

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Warren Buffett Is Even Better Than You Think

Warren Buffett is an even better investor than you think.

The Oracle of Omaha released his latest annual letter to shareholders of Berkshire Hathaway Inc. on Saturday. It’s a good excuse to marvel anew at Buffett’s track record, particularly at a time when stock pickers are losing their aura.

Buffett famously likes to invest in companies that are highly profitable and selling at a reasonable price. That formula has routinely beaten the market, according to University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French.

The Fama/French US Big Robust Profitability Research Index — which selects the most profitable 30 percent of large-cap companies — beat the S&P 500 Index by 1.2 percentage points annually from July 1963 to 2017, including dividends, the longest period for which returns are available. The profitability index also beat the S&P 500 in 81 percent of rolling 10-year periods.

Similarly, the Fama/French US Large Value Research Index — which selects the cheapest 30 percent of large-cap companies — beat the S&P 500 by 2.3 percentage points annually from July 1963 to 2017, and in 82 percent of rolling 10-year periods.

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