Normally I would have written an article for this month’s Current Observations however with our big news, I decided to share our joy with you, our clients. Rest assured I’ll be back for next month’s edition.
William Ali’i Sutherland
Born: Friday, April 12, 2013
Weight: 6 pounds, 8 ounces
Length: 19 inches
We are blessed to welcome our son, William Ali’i, into the world. He was born in Honolulu on Friday, April 12, 2013 at 9:00 in the morning. He weighs 6 pounds and 8 ounces and is 19 inches long.
Mom and baby are doing well, and big brothers and sister are very much looking forward to meeting him soon!
Our thanks to all of you who have prayed and meditated over this pregnancy and have held our family in such love while Amy was being cared for in Honolulu for the past ten weeks. We are so grateful. Many of you have wondered about Will’s name so here’s the story:
We liked the name William and started calling this baby William from the moment we found out we were expecting. Later, Paul’s mom unknowingly confirmed our feelings about his name, when she told us that out of all the names in the world, the one name she loved and had always wanted for one of her children or grandchildren was William! The name William means determined, and we couldn’t imagine a more determined little guy who overcame the odds to be born so healthy. Keeping with tradition, we wanted to use a family name as Will’s middle name. The literal translation of the Roman word Paul to Hawaiian is Ka Li’i, meaning
humble or small. The word-within-the-word Ka Li’i is Ali’i, which means chief. The Ali’i were the highest noble rank and ruling class in ancient Hawaiian society. In choosing the name Ali’i, we honor our family’s heritage, William’s Hawaii birthplace, and two virtues we admire (humility & leadership).
Blessings, Paul and Am
Q: I am 65 and retired. What are the appropriate portions of my portfolio to be invested in stocks, bonds and cash (aka “asset allocation”)?
A: Concepts like asset allocation, when applied as a blanket rule, dangerously oversimplify investing and financial planning. At its core this concept implies bonds are (only) for income and stocks are (only) for growth, and it is not important to do the hard work of analyzing each investment or strategically managing the composition of a portfolio. By bulking the ownership of individual and very diverse investments into oversimplified asset classes, it removes most of the powerful options investors have available.
Simple classification of holdings into stocks, bonds and cash has little to do with the risk and return characteristics of these holdings. For example, there are plenty of bonds (short-term government bonds, for example) with risk-return profiles very similar to “cash” (high liquidity, low credit risk). There are also bonds, such as high-yield or distressed bonds, with characteristics much closer to stocks. Then there are foreign bonds, where expected returns may partially or even largely source from changes in currency rates rather than from yield or domestic price appreciation. On the equity side there are positions that are technically classified as stocks, such as those of companies that have announced wind-down strategies or are subject to a pending acquisition, that exhibit a risk/return profile that is much more “bond-like.” Under various circumstances one, all or none of these might be appropriate for a specific investor’s situation.
It is also important to keep in mind that investment prices and external variables like inflation are constantly changing, making static asset allocation a potentially dangerous game. When government bonds are yielding 15%, like they were a few decades ago, would it be appropriate to allocate the same portion to bonds as when their yields are 1% to 3% like they are now? All things being equal, it makes more sense to own more bonds when their yields are higher rather than stick to a static allocation. But there have been times when bonds were yielding 15%, inflation was 20% and investors were losing 5% of their purchasing power. By contrast, if we are in a deflationary environment (think Japan the past decade or the U.S. in ’08-’09) those 1% to 2% bonds may actually provide greater growth in purchasing power than the 15% bonds did.
On the stock front: Is a stock that pays 10% in dividends more appropriate for a retired investor than one that pays no dividends? Normally, higher income-generating stocks offer more stability and consistency of return. But again the devil is in the details. What if the non-dividend payer has no debt, is in a great market with monopoly-like characteristics, has excess cash, and is selling for a price at which the company’s free cash flow is 20% of the stock price; whereas the one paying the 10% dividend is highly indebted and is not earning the dividend it is paying?
The point is that there should be no “proper” asset allocation or simple recipe. Investing is dynamic. Investors willing and able to discern the multitude of potential advantages some investments offer over others are at a distinct advantage to those who oversimplify.
Our team does not formulaically apply set rules for the proportion of stocks, bonds and cash in the management of client portfolios. In other words, asset allocation does not drive our investment process. Instead, each portfolio’s allocation to stocks, bonds and cash at any snapshot in time reflects our team’s assessments of client parameters (such as portfolio liquidity needs, tolerance of portfolio volatility) and the expected risk-adjusted returns of each existing portfolio position. Our investment process is very much a dynamic one driven from the “bottom up,” one position at a time. The result of this process is an asset allocation that evolves with our assessments of portfolio positions and new investment opportunities.
Q: In your last Q&A, you implied that a stock market correction could be on the horizon. Should I move some extra money to the sidelines?
A: The short answer is that FIM Group has already been “moving some money to the sidelines” inside your portfolio. The longer answer requires first a clarification of what was actually said in the prior article. In summary:
This means it is almost NEVER in your interest to abruptly move money to the sidelines in response to prediction, fear or news. Instead, as your portfolio liquidity needs or tolerance for volatility change, be sure to discuss it with your FIM Group adviser or planner so that we can proactively make the appropriate portfolio adjustments.
From a portfolio management standpoint, FIM Group’s investment approach of letting prices influence our investment timing decisions naturally moves some assets to more defensive allocations as investments get highly valued. In the past few months we have taken some profits, reduced some equity exposure and increased our allocation to defensive investments, especially in our more income-oriented portfolios.
Late evening March 15, 2013,
somewhere over the Pacific Ocean ...
After three weeks of field-tripping through Singapore and the major cities of Japan, I start this note from the back of a Boeing 747 bound for Detroit. Eyeballs saturated with multiple hours of in-flight video entertainment and the family’s carry-on snack inventory reduced to crumbs, our three-year-old Noah and six-year-old Maia are out for the count. With any luck, they will be snoozing until touchdown in the Motor City. Their internal clocks will be screwed up for a few days and their stomachs will go through a withdrawal process after daily fixes of curry udon (the noodles Noah requested every day) and natto (the fermented, sticky soy beans that Maia couldn’t get enough of). But they will surely adjust back to Northern Michigan life far sooner than their father, who nearly 20 years after he first went to sushi-land as a college student seems to be rapidly losing his immunity to jet lag.
On the Scene of a Godzilla Rally
While week one of my trip visiting FIM Group portfolio companies in tropical Singapore was insightful and a nice break from the cold, it was the two weeks in Japan that I enjoyed the most. This was in part due to the weekend time spent with my wife’s side of the family in the small town of Hikone, and nights out in the mega-city of Tokyo catching up with old friends. But as one who closely follows global market developments as part of his portfolio manager role here at FIM Group, it was a great chance to be back on the scene of a market that has been roaring like Godzilla since a change in political leadership last fall.
Long ignored by many global investors as a post-credit-bubble basket case, the Japanese stock market has rallied more than 55% since last November when Prime Minister Shinzo Abe (pronounced “ah bay”) took office. Abe, who ended his previous run as PM for health reasons in 2007, came back as Japan’s sixth leader in six years. Without wasting any time, he produced an Abenomics “three-arrow” strategy of inflation-targeting monetary policy (money-printing), additional government spending, and various deregulation action items that hit global stock, bond and currency speculators like a heaping spoonful of wasabi. The shock to their senses that a Japanese leader was going all-in to combat decades of deflation reactivated appetites for risk, sending Japanese stocks sharply higher and the Japanese yen sharply lower.
Channeling Herman Cain
Of the three arrows in Abe’s quiver, money-printing will be the first to be fired. On April 4, newly installed Bank of Japan (BOJ) Governor Haruhiko Kuroda announced plans to one-up even the great money manipulator Ben Bernanke. Seemingly taking a page from Herman Cain (remember 999?), Kuroda unleashed his easy-to-grasp 2222 strategy, which commits to doubling Japan’s monetary base and doubling the BOJ’s holdings of Japanese government bonds with a goal of hitting 2% annual inflation in the next two years (Figure 1). This bond buying amounts to 7 trillion JPY (approx. $70B) per month and will conveniently soak up 70% of the entire government’s debt issuance during the period. As a percent of Japan’s annual economic output, the BOJ balance sheet will expand to 30% of Japanese GDP, or twice the level of Bernanke’s quantitative easing experiments here in the U.S. Kuroda will also directly intervene more aggressively in Japan’s stock markets through purchases of Japanese real estate investment trusts and exchange-traded funds. In short, Kuroda’s action plan may well be one of the biggest monetary policy dice-rollings of all time. A return to inflation, he hopes, will spur a revival of consumer spending (paging all Japanese consumers, you better buy that new Toyota now before its price goes up 2% next year...) and spark a new trend of economic growth.
Not Counting on a Policy Miracle
Despite the massive response in Japanese stock prices and the nearly 25% drop in the value of the yen against the dollar since Abe took office (Figure 2), most executives I chatted with, both in Singapore and Japan, were only lukewarm toward the prospects for Abenomics. They expect that if the yen does indeed stay suppressed (or “fairly valued” as is the Japan, Inc., company line), the country’s export machine should see higher profits. Some of these profits might even eventually filter down to the salarymen and women on the front lines whose wages have been going nowhere for years (Figure 3). That seems to be what the Abe/Kuroda tag-team is counting on to break the deflation trend that has dominated the economic landscape in Japan for decades.
Yet none of the executives I spoke with was banking on a policy miracle for the myriad of challenges facing Japan (including a shrinking population and an unsustainable debt situation that will likely get worse before it gets better under Abenomics). Instead, they remain intent on pursuing strategies to grow despite such headwinds. Cosmetics giant Shiseido*, for example, has already spent years incrementally building up its international businesses to offset the expected long-term decline of the domestic market. International sales now comprise 45% of Shiseido’s global sales and are expected to take an even larger share in the years ahead. Telco maverick SoftBank*, meanwhile, is seeking to grow abroad in a much more accelerated manner. Its proposal to buy 70% of Sprint, if approved by regulators and Sprint shareholders, will transform it from a domestically focused business to a truly global one nearly overnight. Then there are others with little ambition to grow abroad that still continue to find ways to boost the bottom line. Saizen REIT*, for example, a Singapore-listed, Japan apartment-focused real estate investment trust, has worked tirelessly to restructure debt and optimize its portfolio of properties over the last few years. The result has been growing portfolio income, reduced interest expense and increasing distributions to shareholders.
Giddiness Will Fade as Hard Questions Resurface
Such company-specific initiatives will be even more critical for Japanese companies once the short-term buzz of loose money and a cheaper yen wears off. And let’s face it, while Japan’s stock and bond markets are now giddy about Abenomics, no one really knows how these government policies (and their unintended consequences) will play out. Will a generally thrifty (and increasingly senior) Japanese consumer quit their conservative spending habits cold-turkey and become raging shopaholics? Will a hoped-for wealth effect from the boost in Japanese stock prices really take shape given a Japanese household aversion (and extremely low allocation) to stocks? Will South Korea and China stand by as their core export industries lose competitiveness to Japan thanks to the slumping yen? Will the yen’s fall actually work against a nation that must import nearly 100% of its energy needs? And then there’s that whole working population implosion thing (Figure 4), a reality with economic consequences that could dwarf Japan’s current woes. The BOJ may be able to print trillions of yen, but unless the fascinating 3-D printing space really leaps forward, I would not bank on Kuroda’s ability to print babies anytime soon!
For a valuation-sensitive investment manager like us, the unlikely sustainability of Kuroda’s monetary wasabi and Japan’s longer-term demographic, energy and public finance challenges make it difficult to view the recent ramp in stock market prices as a back-up-the-truck-and-buy opportunity. In fact, we’ve been taking profits in several Japan holdings as their stock prices hit our fair value targets during this Abenomics rally. Without a doubt, Japan is home to quite a few high-quality companies with promising futures. At the right price, some of these will make fine candidates for our client portfolios. In the meantime, we’ll let others surf aggressively on the tsunami of monetary liquidity coming out of the BOJ and stay highly disciplined in our stock-picking there.
For more, on Zach’s trip to Japan, please visit the replay of our webinar “Bullet Trains, Wasabi and Abenomics: A Field Trip to the Land of the Falling Yen” at www.fimg.ne
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