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2013 September Newsletter

Paul Sutherland, CFP®
By: Paul Sutherland, CFP®

Sexy Man, Armageddon, Volatility and Value

Late last year, the People’s Daily website, a mouthpiece for the Chinese Communist Party, picked up and ran an article declaring North Korea’s leader Kim Jong Un the “Sexiest Man Alive for 2012.” The story noted Jong Un’s “impeccable fashion sense, chic short hairstyle and famous smile,” and the editors of the Chinese website added their own 55-image photo gallery of the dictator in various heroic poses. What they initially failed to pick up on, though, was one minor little detail: the whole thing was a spoof created by U.S. comedy website The Onion. Twenty-four hours and a tough lesson in the fine art of satire later, the article and photo collage were quietly removed from the site.

This “oops” moment reminded me of an article I wrote years ago about “truthiness,” and the idea that facts, especially economic and investing ones, can often be lost in translation or severely warped by the biases of those interpreting them. Filtered, spun and proliferated through today’s golden age of social media, these “truths” regularly influence how we think, vote, live, behave and generally act. They can also produce some pretty irrational investing behavior.

Of late, a “fact” sending waves through global financial markets is one that says the bottom is in for interest rates. With the Federal Reserve set to “taper” its current extraordinary monetary policy of quantitative easing (QE), interest rates MUST continue their upward climb as the biggest buyer of bonds over these last five years heads for the exit. Never mind the experience of the last two “intermissions” amid the Fed’s QE campaign (see Figure 1), when rates actually plunged both times the Fed stopped its bond purchases, or the long historical record of rates tracking economic growth (still extremely sluggish), or the demographic drivers of low rates (see last month’s FIM Group newsletter). No sir. Taper = higher rates = run from your “interest-rate-sensitive” investments.

Income-Oriented Investors Run for the Hills

Figure 1As I write in mid-August, this seems to be the perceived “truth” that has income-oriented investors in a panic. Market interest rates on 10-year U.S. government bonds, for example, have surged more than a full percentage point, or more than 70%, since Bernanke began hinting of a taper in mid-May. This jump has apparently driven many owners of boring, income-oriented “widow and orphan investments” like preferred stocks, bonds and the common stocks of utilities, telecom companies and real estate investment trusts to jump ship en masse. The Dow Jones Equity REIT Index, a basket of real estate investment trusts, is down more than 15% from its high of a few months ago, while the largest bond mutual fund in the world, the Pimco Total Return Fund, has lost more than 5% from its recent high achieved in May. Investors in that fund have pulled out a combined $18.4 billion in just the last three months! (Source: Reuters)

You would think that rational investors would be buyers of select income-oriented investments today. After all, getting 70% more yield on a 10-year Treasury bond sure seems like a better deal than it was a few months ago when people were buying income investments like crazy. But we know that investors are influenced by ideology, perception (not facts), and crowd behavior. Our ego prefers being wrong within a group to being right outside the group – as we learned in school, no one likes a “smarty pants” who is right when everyone else is wrong.

Figure 2So investors have been selling their income investments, even though yields have gone up quite a bit. They are buying money market funds where rates continue to hover around “0.” They are also buying what has already gone up, like big, expensive U.S. stocks. The S&P 500 index of large U.S. stocks, for example, now trades at valuations above long-term historical averages across most traditional measures (Figure 2). In short, rather than lock in more attractive, predictable interest and dividend income streams, investors seem hellbent on the “sell low, buy high” behavior that trips them up cycle after cycle after cycle. We have taken the opposite side of that trade. In particular, we’ve been taking profits in certain equity positions and buying beaten-up, closed-end bond funds as Zach Liggett noted in last month’s FIM Group newsletter. We’ve also found some very compelling values in select real estate investment trusts, one of which is featured as the Investment Team Spotlight later in these pages.

Life Will Go On

It is logical to assume that life will go on. Yes, a meteorite could hit the earth, climate change could accelerate out of control, the world’s sexiest man could make good on his serial threats to throw nuclear bombs in all directions, but we have no control over that. Since my job is investing wisely, it is a waste of time to consider “Armageddon” in our process – there is no investment, hedge or fancy exchange-traded fund that would perform well if our world is wiped out. In other words cash, gold, stocks, bonds and real estate become just words in a holocaust. I write this paragraph because client questions keep coming up about the Armageddon scenarios. There seems to be no shortage of “ultra-doom and gloomers” out there with “facts” to spin and snake oil to sell to those in the market for Armageddon insurance. Rather than worry about such extreme scenarios, I encourage folks to worry instead about the following: Are you just following the crowd? Are you continually testing “facts” and looking for the truth? Do you believe that a portfolio’s job is to accomplish a real-life goal, like staying retired? Do you have the temperament to be patient enough through inevitable periods of volatility and the ability to make tough investment decisions in such periods to benefit from this volatility?

Case Study 1: Value Amid Volatility

W.P. Stewart is an investment management company formed in 1975 that we started buying for client portfolios in 2008, when the price was around $19/share. Less than a year prior to our first purchase, shares had traded at more than $150/share. During the first seven months of our ownership, W.P. shares slumped all the way down to $1.70 as the global financial crisis took its toll and tax loss sellers harvested extreme losses. We added to our clients’ positions in W.P. Stewart over the years, averaging down to a cost of under $7/share. Eventually, we became the third largest investor in this money manager with a stellar long-term track record of performance.

On Thursday, August 15, I received a call from W.P. Stewart’s president as news hit the tape that the company had received an offer to be bought for $12.00 a share in cash plus a contingency right for an additional $4/share if certain conditions are met within three years. Think about this share price volatility. Since we started buying W.P. Stewart shares, the stock ranged from a high near $20 to a low under $2. Now a company that manages $444 billion (Alliance Bernstein) comes along and sees real value in the company, offering to pay 65% more than the market price on the day before the deal was announced (with even more upside should the contingency conditions be met). W.P. Stewart’s management and Mr. Stewart himself who owns more than 10% of the company just kept managing their business throughout our ownership. Zach, Suzanne or I would chat with their management team, read their reports, chat with other W.P. Stewart investors – normal stuff of investing – and we liked what we saw. We stuck with the company, kept buying as the share price became cheaper, and now have been rewarded handsomely for our patience. We saw the value in the company while others just saw a company that was “going nowhere” – judging the company not on its fundamental value, as a company, but based solely on its share price.

Case Study #2: Balmy Singapore

Haw Par Corporation is currently our single largest FIM Group investment. It is a conglomerate based in Singapore that holds interests in manufacturing, health care, leisure, investments and real estate. The company is probably most known around the world for its line of Tiger Balm-branded ointments. We first bought Haw Par for clients in December 2007, for around $4.25/share. Since then, the company’s share price has fluctuated from a low of $1.95 during the financial crisis to a high of $6.23/share reached earlier this year. During this holding period, we have averaged down our cost to under $3.50.

Haw Par has paid cash dividends every year we have owned this solid company, and in May it paid a 10% bonus dividend in shares. According to the company’s most recent report, the company’s “net asset value” as of June 30 converts to around $8.35/share. This compares to a recent US$-converted share price of only $5.70. We believe this discount presents a great bargain, and we continue to build our position alongside Haw Par’s Chairman and largest shareholder (33%), Dr. Wee Cho Yaw, who just happens to be Singapore’s wealthiest man. (Please note that Haw Par shares trade in 1,000 share lots, which prohibits some FIM Group accounts from holding this name.)

Like W.P. Stewart, Haw Par management continues to build value, even if this value is under-reflected in the share price. By practicing strategic patience, something that we believe is one of the key attributes of successful investors, we expect to eventually realize the full extent of this value over time.

Strategic Patience

Patience is virtue, but stubbornness is not. Sometimes it is appropriate to “give up” on an investment and sell it. So far this year we have sold a number of investments – some at losses – when confronted with either: 1) deteriorating fundamentals (changes to competitive conditions, management performance, regulatory environment, etc.); or 2) superior investment prospects elsewhere.

When we felt interest rates were headed higher earlier this year, we started selling many of our interest rate-sensitive investments. As luck would have it, the bond market sell-off brought us back to many of these same investments as buyers once again. We’ve also been rotating some of our precious and industrial metals mining holdings amid significant weakening of industry conditions. Our goal in these rotations is to own those companies with staying power should commodity prices stay depressed for awhile as well as those with dry powder to acquire projects at distressed prices. Our team also sold Mobistar, a Belgium Telecommunications company, at a loss, after the company slashed their dividend as competitive and regulator conditions deteriorated far beyond our expectations.

At FIM Group, we manage client funds via separate accounts, which allows each client the opportunity to see how “sausage is made,” so to speak. Many investors just own mutual funds or other pooled investment vehicles where the day-to-day details are hidden. We believe in straightforward, honest transparency, and as a client you see it all. Our mistakes, our fees, our losing investments and winners are all disclosed for your review. The 30 of us are here to chat about “what you see,” so if you ever wonder why we bought some W.P. Stewart at $10 and then more at $5 and still more at $7, just call and ask. Equally if you’re wondering why we sold an investment we recently bought – please don’t hesitate to be in touch.

Wonderful World

I feel some Catholic guilt, even though I am not guilty when I state that I believe the next 10 years will be great years to be investing. How can I think this way amid all the “facts” floating around about deficits, interest rate spikes, flash crashes, war, leadership deficiencies, climate change and the myriad of other macro issues our team confronts day in and day out? Primarily because it is during periods of fear that historically create the best opportunities for patient, thoughtful investors. Look at 2008–2009, or the GFC (GREAT FINANCIAL COLLAPSE) as a money manager friend from Australia likes to call it. Who suffered the most? Those who sold at distressed prices. Who made money? Those who stayed calm, invested wisely, and realized that people would still buy groceries, fix up their homes, heat them, send their loved ones flowers, call their friends and family, and basically keep on living. These same “winners” also seem to recognize that by the time the masses learn of any “problem,” a solution to said problem is likely already well underway.

There are more than 50,000 stocks to invest in worldwide, and many additional bonds, preferred stocks, properties, gold, base metals, soft commodities, currencies, money market instruments, CDs and the list goes on. The key is to patiently invest in assets that on a “risk-adjusted” basis have the ability to help move you toward your portfolio’s goal. Stay focused on long-term outcomes, acknowledge that markets regularly go through cycles, and keep a healthy skepticism toward the “facts” as they filter down through our wonderfully networked world. Doing so gives us a much better shot at hitting our financial and life goals and may even keep us from becoming the next victim of those mischievous folks at The Onion.

Matthew J. Desmond CFA®
By: Matthew J. Desmond CFA®

Take the Stress Out of 401(k) Decisions

Charles Schwab’s Schwab Retirement Plan Services recently released some data from its 2013 401(k) participants’ survey*. Nine out of 10 respondents say they are relying on themselves to fund their retirement, and six out of 10 report that their 401(k) is their largest or only source of retirement savings. Owing, perhaps, to well-performing markets dating back to 2011, 401(k) participants are also feeling pretty good about their retirement accounts. Nearly three-quarters reported that their 401(k) recovered as fast, if not faster, than expected from the financial crisis; over the past two years more than half have increased their contributions; and 70% believe their 401(k) is in better shape than ever. By and large, that’s good news. Unfortunately, it’s only half of the story. The same survey also uncovered some deep-rooted problems that likely date back to the introduction of the 401(k) in the late 1970s. 401(k) participants report confusion about investments (more than half of the respondents said investment information is more confusing than health care benefits), uncertainty about their choice of investment options (reported by 46%), and stress about choosing their 401(k) investments (reported by 34%).

The gulf between participants’ enthusiasm for their 401(k) plans and the 401(k)-caused anxiety shouldn’t be surprising. After all, how many participants, busy building expertise within their own profession, would have the financial training and education to competently structure and execute a long-term investment plan geared to meeting their retirement goals? The 401(k) is a feature included in many company retirement plans that allows an employee to make tax-advantaged contributions to the plan. It is an important enabler of the long-term transition away from defined benefit plans, through which employers would guarantee – take responsibility for – employee retirement income (usually based on years of service and compensation level) to defined contribution plans, in which the responsibility for funding retirement income shifts more to employees. With defined benefit plans, employers also typically avoid much of the responsibility – and accountability – of managing the plan’s assets. That falls to each participant. Empowering individuals to take command of their own retirement is certainly a laudable goal. However, while 401(k) participants value the importance of their plans to their future, they’re also straddled with the worry, concern and uncertainty of not knowing how to best manage them.

To be fair, plan participants aren’t left completely in the dark. Employers that give participants discretion over their 401(k) investments must provide enough information for participants to make meaningful decisions. Some plan sponsors will provide effective financial education opportunities to help participants. Many others provide plenty of information but very little real education. Realistically, however, few participants will have the time or the inclination to develop the expertise for overseeing their retirement investments. Uncertainty, confusion and the accompanying stress, then, would be the expected outcomes for plan participants.

One frequently proposed solution to this issue is to require more and more effective education for plan participants. Education can certainly help. Time availability and interest, however, will still hinder most 401(k) plan participants from achieving a sufficient level of investment competence. Our solution at FIM Group: Take each plan participant on as an individual client who has access to the same professional investment management and financial planning services as any FIM Group client. FIM Group clients do not make the buy/sell decisions in a portfolio, but, with guidance from financial planners and portfolio managers, they select a portfolio strategy that sets the parameters for the investment of their funds based on their objectives, age and their individual tolerance to volatility. What’s more, because FIM Group adheres to a fiduciary standard that requires its financial professionals to put its clients’ interests first, plan participants/clients receive unbiased, independent advice that is not compromised by self-interest. Each participant can also reach out to FIM Group’s professionals, each of whom has years of experience and top credentials, for advice on any financial issue. After all, nearly every financial question will relate either directly or indirectly to retirement. Granted, the do-it-yourselfer with the financial know-how may not like this model. For the vast number of 401(k) participants whose accounts suffer from decision anxiety or just plain willful neglect, the FIM Group retirement plan model solves many issues and provides great benefit. Indeed, the fore-noted Schwab survey also found that 401(k) participants are almost twice as confident (61% vs. 32%) making investment decisions if they have help from a financial professional than if they decide on their own.

*SOURCE: 2013 401(k) Participant Survey conducted by Koski Research for Schwab Retirement Plan Services, Inc. The survey is based on 1,004 interviews and has a 3% percent margin of error at the 95% confidence level. Survey respondents worked for companies with at least 25 employees, were current contributors to their 401(k) plans and were 25-75 years old. Survey respondents were not asked to indicate whether they had accounts with Charles Schwab. All data is self-reported by study participants and is not verified or validated. Respondents participated in the study between June 5 and June 11, 2013.

Alice McDermott, CFP®
By: Alice McDermott, CFP®

Question of the Day – “When Can I Retire?”

As you can imagine, this answer is different for everyone. The two biggest determining factors are a person’s after-retirement expenses and income. Some people may have a mortgage payment, while others may not. Some may need to pay medical insurance premiums, while others may be covered under an employer benefit program or are age 65 and on Medicare. Some may want to travel the world, while others may stay close to home and “give back” to their community through charity work. The point is, people’s goals and needs are different – the only question that matters is how much will YOU need at retirement?

So when the question arises with clients, we first discuss time horizon until retirement. Five years away? Three years? We then review their budget and how it may adjust at “retirement.” Will their income needs change? Will they continue to work? Will they change careers (some do!)? Does it make sense to apply for Social Security benefits, or should they wait? These are some of the important considerations before determining if one is ready to retire.

To give you a better idea of how it all plays out, let’s consider a “fictional” case: The current value of John (age 63) and Sally’s (age 62) investment portfolio, which includes a Trust account and two retirement accounts, totals $1.2 million, and their investment profile is “Balanced”.

John and Sally have decided they’d like to retire the year John turns 66. Because their time frame is just three years away, it makes sense to reduce their investment profile now to a more “income-oriented” and less “growth-oriented” position, since the idea will be to draw income from their investment portfolio. John plans to work part-time as a consultant, with expected earnings at $30,000/year for as long as he’s able, or well into his 70s. John will apply for Medicare at age 65, and Sally will continue on her employer’s medical plan until she too is eligible for Medicare the following year. They’ve decided it makes sense to forgo applying for Social Security benefits until Full Retirement Age (FRA), or age 66 for both, so their benefits are not affected by other earned income. Their total Social Security income when Sally applies at 66 will be $3,500/month.

They expect their expenses at retirement will be roughly $10,000/month, which includes a $2,800/month mortgage payment on their residence. Because they were able to refinance a few years ago, and lock in a low 30-year rate at 4.5%, it makes sense to keep the mortgage and the tax benefit it provides. Although both are healthy, they’ve decided to purchase supplemental Medicare coverage because they do not want to bear the cost of unexpected medical expenses should they arise (plus, they do not have much confidence on how the Affordable Health Care Plan will play out when they retire). Sally’s income will remain at $50,000/year until age 65, at which time she’d like to stop working and focus on her passion of pottery, as well as give back to her community through various service avenues. Another important piece of their planning is they each have 20-year-term life insurance policies of $500,000 – these are due to expire when John turns 70 and Sally turns 69. They purchased the policies to protect themselves in the event of premature death during their remaining earning years.

Based on this information, and assuming they are both living, their projected income when Sally turns 66 will be $6,000/month ($2,500/month from John’s part-time consulting and $3,500 from their combined Social Security benefits), which means they’ll need to draw $4,000/month from their investments to supplement the cost of their monthly expenses. John and Sally indicate they have no strong desire to leave a large inheritance to their three children because they are all are doing well financially, but they do like the idea of leaving a small legacy for their grandchildren’s education, if needed. Their primary goal is to live a good, full life to the very end, while preserving their investment principal, for unknown and potential long-term care needs. If their portfolio is invested “appropriately,” i.e., where they are earning about 4%/year of income from their investments, most financial advisers would feel comfortable stating they could withdraw up to $4,000/month ($1.2 million x 4%/12 = $4,000), yet still allow growth of principal for inflation. John and Sally understand that in order to achieve their income need, in this “no-risk,” 0% interest rate environment, they will need to accept some volatility of market value.

In conclusion, the timing of one’s retirement is very individual and all very relative. The first step is to get your budget defined and under control during your final income-earning years. Second is to make sure your portfolio is positioned appropriately to provide the income you may need. Feel free to contact one of FIM Group’s Certified Financial Planners to discuss your timeframe to retirement, and to make sure your investments are in line with your retirement goals. 

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