Abramson Finding Indexing's Appeal Gaining In Tough Times

October 21, 2008

Analyst turned passive advisor seeing market turmoil spurring interest in low-cost investing. 


The value of disciplined, low-cost and highly diversified investing is really paying dividends for Lorne Abramson these days.

Despite turbulent times in the markets, the Burlingame, Calif.-based portfolio manager says he's finding his high net worth and institutional clients "shaken but not stirred."

"They're not jumping ship. And actually, we're seeing a lot more unhappy investors questioning their advisors' active strategies contacting us," said Abramson.

Along with his wife, Elana Lieberman, he runs ELM Advisors near San Francisco. Both are staunch supporters of passive asset-class investing. And each started in finance as stock analysts at institutional research and money management shops. Abramson primarily covered banking stocks at SKBA Capital Management, while Lieberman tracked insurance companies at Sanford C. Bernstein.

"We both saw from the inside how hard it is to add value over indexes," Abramson said.

Nobel prize-winner William Sharpe was also a big influence in their transformation to index investing. The professor met Lieberman's father, who was also in the money management business and served as an original member of ELM's team, years ago when both worked at Stanford University.

Sharpe's work on capital asset pricing models "had a huge impact on our thinking about the efficiency of capital markets," Lieberman said.

"We've come to the conclusion that markets aren't perfectly efficient, but it's best to act like they are," Abramson said.

Zero-Sum Game 

Stock markets are still brutally competitive, he adds. That's even truer today with the proliferation of hedge funds and technology. "And the drag of costs for active management makes it a zero-sum game and puts managers at a disadvantage from the outset," Abramson said.

ELM uses stock exchange-traded funds to heighten tax efficiencies in portfolios. It also invests through Dimensional Fund Advisors and Vanguard open-end index funds. On the fixed-income side, the advisory prefers to build individual bond ladders for clients.

An average portfolio run by ELM has a weighted average expense ratio of around 0.17% right now.

Typically, Abramson will recommend seven to 10 core stock ETFs or diversified funds. "Taking a value approach with a dedicated bias to small-caps makes sense to us," he said. "Investors can reasonably expect a greater return over time since value stocks and small-caps have greater volatility and risk."

The couple use Vanguard Total Stock Market ETF (NYSEArca: VTI) and Vanguard FTSE All-World ex-U.S. ETF (NYSEArca: VEU) for broad large-cap building blocks. And then they'll use SPDR S&P International Small Cap (AMEX: GWX) for additional diversification.

On the domestic side, Abramson likes to use some of the Vanguard Small-Cap ETF (NYSEArca: VB) along with the DFA U.S. Targeted Value (DFFVX) mutual fund for small-cap value exposure.

"We also see value in diversifying through REITs," he added, suggesting the Vanguard REIT ETF (NYSEArca: VNQ).

Abramson also has a long-standing interest in socially responsible investing. In fact, he's had research published in the field by the Journal of Investing and others.

"Even with the low-cost SRI funds we favor, the expense ratios are higher. So there's a cost involved in building social investing screens into funds," said Abramson. "It's important for people to realize that fact and to go into SRI funds with their eyes wide open."

A Layered Approach 

First and foremost, he adds, SRI investing should be considered an overlay of traditional indexing.

"You can't forget the underlying fundamentals of passive investing," Abramson said. "You can create diversified, socially responsible investment portfolios that are still focused on the best aspects of low-cost, diversified indexing. But there are still some gaps in terms of what asset classes are available with SRI funds in the marketplace."

Two core U.S. stock mutual funds he uses for investors interested in SRI investing are the Vanguard FTSE Social Index Fund (VFTSX) and the TIAA-CREF Social Choice Equities Fund (TICRX).  

ELM doesn't target commodities exposure or other alternatives exposure. "Our clients get exposure through energy companies and commodities producers already held in their broad market index funds," Abramson said. "We're not sold on the value of overweighting commodities or energy."

Part of his reasoning for avoiding targeting direct exposure to commodities is due to the work of David Swensen, who runs Yale's endowment portfolio.

"I love his second book, which is geared towards individual investors and makes no mention of the need for commodities exposure," Abramson said. "And even John Bogle has pointed out that commodities have no intrinsic value—they're not producing assets."

ELM also believes in rebalancing once asset classes move outside of certain performance bands.

"That's something we're continuing to monitor," Abramson said. "Right now, that's something we're looking at on the stock side—rebalancing asset classes to make sure people aren't falling too far below their target asset allocation levels."

-- This report was submitted by Murray Coleman.



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