By: Paul Sutherland, CFP®
We hold these Truths to be self-evident, that all Men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness. That to secure these Rights, Governments are instituted among Men, deriving their just Powers from the Consent of the Governed. And that is self-evident.
I am proud to carry a U.S. passport and proud of the fact that I am an American. We are truly a great country, but we are not great because we have a big GDP or a Declaration of Independence or even because we landed on the moon. We are great because of our people, who we are and what we represent to the world. I have traveled a great deal over my 40-year career, and many of us seem blind to what a wonderful place we have been blessed to call our country.
We seem indifferent and unappreciative of how lucky we are to be Americans. So to battle indifference and lack of recognition, I am going to list some of my favorite things about the Good Ol’ USA. It is July after all, our country’s 238th birthday, and a great reason to reflect on our history and accomplishments. Here, then, are a few things that make me proud to be an American.
We can openly disagree with our government, and we can be critical of our leaders and not face jail. We allow misinterpretation of the facts and allow liars to lie; all the while we trust our citizens and the process to have the wisdom and discretion to sort out the truth. While many issues cause me to feel moral outrage, I would not want to trade places with those in China, Syria, Russia, North Korea, or Rwanda where freedom of expression does not exist.
Our freedom to choose how we spend our time, money, talents, and votes is often taken for granted yet immensely powerful. Not happy with how your local or national officials decide to tax and govern you? Vote them out. Not thrilled with how investment advice is offered to the public? Start a new investment firm. Worried about the junk in your food at family meal-time? Buy from farmers you trust or grow your own. Thanks to a generation of innovators, the ability to engage in change creation in this modern age of social connectivity is easier than ever before. As Nike tells us: Just Do It!
When you look at wealth, statistically, we have something on the order of $260,000 in per capital national wealth (PCW). This wealth includes a wonderful interstate system of roads, libraries, schools, companies, homes, and more. India’s PCW is $2,667 (2011) and China’s total wealth is one-third of the USA’s, which is then divided by their 1.35 billion citizens, so they have a lot of catching up to do. This wealth didn’t just appear by magic. Our citizens created it with hard work and entrepreneurial savvy. Even in our current economic funk, we are business and job creators, starting more than 500,000 businesses each month and creating more than a million new jobs last year alone!
While headlines remind us daily that we are far from perfect, as a nation we still look out for one another and give a tremendous amount back. Philanthropy seems to be deeply embedded in our DNA, ranging from communities that rally for families in need via local spaghetti benefit dinners, to the multitudes of non-profits pursuing their respective missions, to the private foundations of our nation’s most financially successful businesspeople. We give our time and money because we care, and this level of giving is unrivalled anywhere in the world.
But for me, the diversity of our fine country is perhaps what I like most. The diversity of our landscapes, the diversity of our ideas, and most of all the diversity of our people. We are a good lot, we try to help the world, we try to do the right thing. We are all proud of Thomas Jefferson, Benjamin Franklin, George Washington, and Abraham Lincoln – not because they were rich, could shoot baskets well, act, or win medals. We respect them for their virtue, character, and the values they championed. Our people are what make us a great country – those who came before us, those guiding us now, and those yet unborn. We have character, virtue, resilience, and sustainability in our DNA, so I am confident in our future. Seems self-evident to me.
By: Barry Hyman, MBA
My family’s behavior during and after my son Josh’s soccer match two weeks ago was a study in human and crowd behavior. Like his dad, Josh is diminutive in stature, the smallest kid on the team. But he is also the quickest. Under normal circumstances, his quickness is overwhelmed by the size and power of the other kids, so he is generally stripped of the ball if he doesn’t pass it quickly. However, on this particular day, with his team behind 0-1, the coach moved Josh to the “forward” or scoring position. The first time the ball was passed to him he burst past the defender and scored the tying goal.
Unlike World Cup soccer where the fans go berserk – as in, “Goooaaaalllll!!!” – his mom and I just politely clapped.
Couple minutes later, the same thing happened. We, like his teammates and their parents, were pleasantly surprised by the unlikely recurrence. We cheered louder, and his mom sent out a proud text to a friend. The third time he scored in the first half, mom busily texted all the relatives. Upon his fourth goal, she was on the phone with the grandparents in New York screaming with excitement (and with the score 4-1 before halftime the coach pulled Josh out). With his fifth and final goal of the game in the second half, mom was throwing fist pumps (okay that was me), and she was ready to hire an agent for what she was certain was her prodigy child (okay that was me, too).
Mom’s (yes, our) response is reminiscent of perennial investor behavior. As prices of investments rise and the likelihood of them rising more seems low, the majority of investors remain skeptic. So early in an advance, many in the “crowd” keep much of their investible assets on the “sidelines.” But as momentum rules the day, prices continue to advance, enticing more investors with weaker conviction in their skepticism to join the party, and driving prices higher. Eventually, a feeding frenzy ensues as all but the die-hard skeptics throw in the towel and “buy!” (think real estate, commodity, precious metal, or stock bull markets). At the conclusion of the frenzy, nearly everyone who had money on the sidelines is “all in,” and there is little more “dry powder” to further fuel the advance.
Accompanying such an advance in prices, as Zach explained mathematically with graphs and Paul showed emotionally with his ubiquitous sine wave in last month’s newsletter, prices and sentiment move from bargain and washed out, through fair and rational, to unrealistic and unsustainable levels, and eventually revert toward their mean levels. Most people with experience of market cycles know what happens next. And it usually ain’t pretty. Prices (of assets that are overinflated) fall, valuations return to or fall below fair levels, and sentiment turns from ebullient to rational and often continues through to despair. Most important of all, a lot of wealth changes hands in the process as money rotates from irrationally priced to undervalued assets. Investors who position their portfolios in undervalued assets are generally the recipients of that wealth transfer.
So how does a prudent investor or investment manager mitigate those cycles and still participate in the age-old practice of building wealth and benefit from the irrationality of investor folly?
In a nutshell, it is to stick to a disciplined process.
FIM Group’s Strategy
As valuations of popular stock and stock market indexes have risen to levels well above rational levels, FIM Group has employed several tactics as part of this discipline process. These include rotating out of fully valued and into under-valued investments, increasing cash and cash-alternatives, and investing in securities that have been overlooked or overly punished despite the relatively robust environment for stocks. What follows are a few examples of the disciplined investment action our team has been taking amid this environment. (Please note that not all of these investment actions apply to all client accounts.)
Trimming Interest Rate Sensitive Closed-End Funds
Last year as the Fed’s intention to taper its rate of bond purchases became evident, holders of many interest rate sensitive investments, such as bonds and high dividend paying stocks, dumped them, driving their prices to depressed levels. Some closed-end funds (funds that trade on stock exchanges at prices independent of the value of their underlying holdings) got doubly trounced. Not only did the value of the holdings in these funds fall (this is also called a fund’s net asset value or NAV), but fearful investors drove the market prices of the funds themselves down even more than the fall in their NAVs. This created a “triple play” for opportunistic investors like FIM Group.
Above is a graph of the price and the “discount to NAV” of one such closed-end fund investment, Blackrock Utility and Infrastructure Fund (BUI).
In the top half of the graph, the blue line represents the NAV of the fund. Again, this is basically the market value per share of all the fund’s holdings. The black line represents the market price at which the fund trades on the stock exchange. In the left half of this graph, you can see that the NAV (blue line) moved up and down but ultimately ended the year (middle of the graph) in December about where it was in the summer at $20/share. The market price (black line), however, fell over the period from more than $18 to around $17. The bottom half of the graph represents the difference between the NAV (underlying value) and the market price of this investment. As you can see, (red area)this difference, or “discount,” maxed out at about 15% in December. In the second half of this period, the price (black line) of this investment rose much more rapidly than the value (blue line) and thus the discount (red) had shrunk to about 7%.
The triple play mentioned includes reaping the benefits of a rising NAV, a shrinking discount, and dividends paid by the fund’s underlying holdings.
Over the period from 9/30/13 through 6/20/14, the value of the holdings inside of this fund (its NAV) rose by about 13%, but investors in this fund earned 26%. The added returns came from the quarterly dividends it paid and the reversion of the discount toward more normal levels. Once the discount narrows back to its “normal” range, prudent investors revisit the merits of continuing to own such an investment and ask themselves whether their expected returns compensate them for the inherent risks of the investment. In the case of BUI, and several other closed-end funds that FIM Group has held over the past few quarters, the bulk of the benefits we anticipated when we first owned them have been realized, and thus we are paring back several such investments.
Opportunities in Shunned Investments
Just as interest rate-sensitive investments were unjustifiably beaten down last year as described in the prior section, there have been other areas where similar opportunities have developed such as Russia and Eastern Europe. Amid tensions between the Russian and Ukrainian governments, we were able to pick up several new investments that other market participants chose to sell to us at bargain prices. These investments include a mobile telecommunications company, a television broadcaster, a retail property real estate investment trust (REIT), and an Austrian-based property company, all trading at valuations well below our estimates of their intrinsic values.
Another shunned investment we have been able to buy at bargain prices is American Realty Capital Properties (ARCP). With central banks globally keeping interest rates low, the prices of most U.S. REITs have now become quite expensive. Dividend yields for many U.S. REITs, for example, are now only in the 3-4% range and near their historic lows. With ARCP, we have been able to buy a high-quality portfolio of U.S. triple net lease properties (and other attractive assets) with a dividend yield of 8%. Investors have dumped this investment in response to unconventional actions of management including a rapid pace of acquisitions and financings, which is rare for normally stodgy REIT management teams. We believe their portfolio is solid with high-quality, high-income generating assets and expect investors to return as they see a few quarters of more normalized (meaning with fewer acquisitions) results.
Maybe not shunned but simply “ignored” describes another type of investment we seek in this overvalued world. One such investment is this month’s Investment Spotlight, soft drink and juice maker Cott Corp. This private label boring company doesn’t have the sizzle of social media, biotech, electric cars, or cloud computing; but it does generate 10% annually in free cash flow.
Conglomerates at a Discount
One of the biggest portions of our portfolios over the past few years has been our allocation to conglomerate or holding company-style investments. These come in various forms. One type is closed-end funds, described above. Another type is structured as a single company that has holdings in many other companies. We like to own these investments when they are trading at market prices that are at a significant discount to the value of the sum of their parts. As some of our favorite conglomerate holdings have risen in price and no longer meet our buy price discipline, we continuously scour the globe for such opportunities. Recently we began buying shares of Symphony International, a London-based holding company that owns and focuses on high growth Asia-Pacific healthcare, hospitality, and lifestyle investments. Our assessment puts the sum of its parts at nearly double that of the price at which the market is currently pricing their shares.
The investment actions noted above are just a small representation of the rational, disciplined process our investment team deploys when managing client portfolios. We realize that the “markets” are really just a conglomeration of participants whose actions can be anything but rational. Just like a proud mom (yes, and dad) can get carried away with their future Pele, so, too, can investors let their emotions derail them from a sound investment process.
In my family’s case, I am just thankful that the great financial innovators of Wall Street have yet to develop a futures market for soccer moms and dads where family nest eggs can be wagered (with leverage!) on the hoped-for golden feet of their sons and daughters. Had I “invested” in such a financial instrument at the peak of our euphoria following Josh’s five-goal outing, I would be sitting on a lot less market value after Josh’s goal production dropped to goose egg levels in each of the subsequent six games.
Yep, we’ll let Josh keep developing a few more skills before making that kind of bet, and we’ll keep our retirement funds under FIM Group’s management. With FIM Group’s disciplined approach designed to stay rational in global markets full of irrational participants, I’m confident that our smartly diversified, proactively managed portfolio will give us our best shot of reaching our family’s long-term financial GOOOOOOOAAAALLS!!!
As more money has poured into global stocks and bonds from investors chasing higher yields than they can get from savings, CDs, or other non-volatile investments, or simply chasing the momentum, values of many investments have reached unrealistic levels to make building a portfolio a greater challenge. As disciplined investors, FIM Group refuses to compromise our value criteria. As a result, it has become more difficult to find enough investments to fill some portfolios. We are only filling portfolios with those investments that meet our strict price/value/risk criteria.
The result is a higher than traditional level of cash and cash-like investments. We believe this condition is only temporary. This, too, will pass.
By: Jeff Lokken, CFP®
In the last few weeks, my wife and I have had the pleasure of meeting our first two grandchildren. On May 2, our son’s wife gave birth to an eight-pound boy named Harrison Jeffrey. Our daughter and her husband followed that up on June 13 with a six-pound, 15-ounce baby girl named Margot Louise. Both babies and their parents are doing well, and this certainly is a new and exciting stage in all our lives.
My own two children, who once were our “babies,” are now parents with all the joy and, of course, responsibilities that come with being Mommy and Daddy. New parents are certainly challenged with the magnitude of the new day-to-day duties of diaper changes and constant feedings, not to mention sleep deprivation. However, despite the day-to-day duties, there are also several financial actions that need to be taken during this time. I won’t advise on the day-to-day stuff, but I certainly can on the financial issues. So here is some advice from Grandpa, which, hopefully, others can pass on to their children.
Although this may sound a bit “tongue-in-cheek,” it is, perhaps, the most important: Make sure the grandkids spend lots of time with their grandmas and grandpas! I know grandparents will dote and spoil them, but they also will create memories that last beyond lifetimes. Most of us who were fortunate enough to know our grandparents can recall at the drop of a hat a memorable and important
time we had with them that continues to influence us daily.
Once the first objective is firmly entrenched, it is time to move on to the financial issues. Certainly these issues may not be as challenging as the day-to-day duties, but they are important. Therefore, I will attempt to make a “list” for new parents. It’s certainly not an exhaustive list, but it’s a good start.
1—Estate planning: It seems somewhat depressing, but considering what could happen should a tragic loss of either Mommy or Daddy is important. Yes, it is time to go see an attorney and create a will, which dictates what happens if either or both parents die. This is particularly important when the children are minors; the attorney will guide you through the process. But before the meeting, you should prepare and discuss several estate-planning points. These include having a guardian for the minor, and making a list of assets and liabilities (including the amounts of life insurance/retirement plans and the named beneficiaries). Additionally, since it is not wise to leave estates to minors or financially unprepared younger persons,you should consider having a trust under your will (e.g., a child’s contingent trust) that would manage and distribute assets and income over a designated time period. Decisions regarding this trust will include: Who should be the trustee? and When and how should the trust assets and income be distributed? A trustee can be a corporate entity and/or a person. The benefit of a corporate trustee is permanence as it does not suffer from the mortality or mentality of a person. Typically, the income from this trust is distributed regularly to the guardians for support, and principal distributions are made for lump-sum expenses such as college education. The principal may also be distributed directly to the children at specified ages. This may prevent distributing too early before a child is financially responsible.
2—Life insurance: Protecting the family against loss of life of a supporting parent is critical. If something should happen to Mom or Dad, the bills still need to be paid. Term life insurance is inexpensive and can protect this risk. The amount of coverage is dependent on the income and assets being protected, so getting a capital needs analysis (i.e., reviewing what happens if either or both spouses die) is helpful. Usually six to eight times the annual income does the job, and a policy for about 20 years is sufficient and will keep the cost down so other things can be done with your hard-earned income.
The primary beneficiary is typically the surviving spouse, and the second or contingent beneficiary should be the child’s contingent trust under the will. It is not a good idea to name a minor beneficiary. For a more in-depth explanation, discuss this with your attorney.
3—Other insurance: Regardless of having a newborn or not, good financial planning requires a periodic review of all other insurance. Make sure disability insurance is adequate to protect income; add your newborn to your medical coverage ASAP; and meet with your property and casualty insurance agent to make sure your home, auto, and liability coverage are adequate. Given limited dollars, you should consider higher deductibles to keep the premium costs down. First-dollar coverage can be expensive. One other insurance policy to consider is an umbrella policy, which protects you from the risk of litigation. Umbrella policies are inexpensive and usually are issued in $1 million increments. This is a good value in this litigious society.
4—Emergency fund: One of the hardest objectives for new parents to achieve is setting aside cash for emergencies, but it is important and needs to part of the budget. Having six to 12 months of expenses in the bank is wonderful. Notice I said “in the bank”: This means these funds should be readily available and not at risk for investment loss.
5—Financial statements: The two most important financial statements you should update regularly are the balance sheet and the cash flow statement. Use a spreadsheet program such as Excel to make a list of your assets and liabilities. When you subtract your liabilities from your assets, you have your net worth. Financial decisions should be made with your balance sheet in mind. Consider how you’re spending and investing may change your balance sheet. In the early stages of planning, I suggest you update the balance sheet monthly, until you get consistent and more knowledgeable in your decision-making. The cash flow is your budget. This takes quite a bit of work, but the benefits are amazing. Again, using a spreadsheet, list all your expected expenses by month for one year. This ensures you pick up those pesky non-monthly expenses. Make two columns for each month – one titled “budget” and the other titled “actual.” Keep track of your expenses each month and note the difference between your budgeted and actual spending. After six months or so, you should have a good feel for your cash flow and be able to make decisions that let you live within your means while building long-term wealth and security.
6—Education savings: College seems far off, but the advantage of saving early is critical. Early savings allows for less money saved and more money for college. This is due to the astonishing principle of “compounding.” Time is your asset, so start as soon as possible. Most states have 529 Education Savings plans that allow for small monthly contributions; no income tax on accumulation or distribution (if used for qualified education expenses); and multiple investment options, including age-weighted programs that become more conservative as the child reaches college age. Some plans even give current income tax breaks.
7—Retirement: Don’t forget about yourself. Most of us have the option to save in a retirement plan through our employer. Many of these retirement plans have matching characteristics. You should at least contribute up to the matching amount to receive the “free” match. A good guide for retirement savings is about 12% of gross income, but anything you do now will pay off down the road.
8—Flexible Spending Accounts (FSA): Check with your employer to see if an FSA plan is available. FSA’s allow you make pretax contributions to assist in paying employment related dependent care expenses.
There are many other financial items that could be addressed for the new parent, but this list should keep you busy enough while you’re changing diapers and feeding your precious one every few hours. Remember to stay balanced in all things – let the children spend time with grandparents (you get a break that way), take care of daily duties, and get your financial house in good order. Good luck, and be diligent in all you do!
There is no Spotlight for this issue.