I remember when I was about 16 years old, my dad, who was an elementary school principal, told me that one of his teachers had remarked that a particular student was “not worth the effort.” And then he said this to me: “Paul, kids are stupid. If you tell them they are smart, they will believe you.” Perhaps a more accurate statement might have been, “Paul, young children are naïve and impressionable. If you tell them they are smart, they will behave as if they are smart and will do better in school.”
Yet I understood what he was saying when he used the word stupid. I’ve also overheard someone call the person on the other end of the phone line a retard. One of the definitions of this word is: “a contemptuous term used to refer to a person who is cognitively impaired.” In our family, retard was and is a swear word. My parents had no tolerance for it, and while I’ve never heard it spoken in our family, I have no tolerance for it, either.
My friend, on the other hand, learned the second definition of retard: a person who is obtuse or ineffective in some way.
So who is right? The word for yes in Greek sounds like the word no in English, and I love spiced African tea, but I love Amy too. Is the word love a true descriptive with meaning? But readers will know that the love of tea is a much different love than the love I have for my wife, partner, and friend Amy.
Today there seems to be an obscuring of the meaning of words, opinion, truth and fact – kind of a rekindling of the word truthiness that was going around years ago on late-night satirical comedy shows.
"People will generally accept facts as truth only if the facts agree with what they already believe."
— Andy Rooney
But this is not funny, it is not good for our economy, and it is not good for peace. Looking at “intellectual integrity” and “truth seeking/fact checking” as some sort of alternative reality can lead to some pretty dumb conclusions.
As “smart” human beings, we make decisions. Decisions are made usually in a rational methodology that weights risks and rewards, and ends in an action. Marketers know this. They also know that if they can influence the “facts” that go into a decision, then they can influence the outcome.
So let’s get to investing. Here are some “facts”:
So now I will tell you a secret: All those statements are wrong. There may be truth in them, and there can be experienced, rational thought put into those conclusions. But, on the whole, to embrace any of those statements as standalone facts would lead an investor toward doom (unless one has very good luck). We should view facts as “friends” that help us make good choices.
"Half a truth is often a great lie."
— Benjamin Franklin
The reason we delude ourselves is quite simple: Our brains are lazy. We don’t want to think, because it takes too much energy. And, laziness aside, if our “thinking” is not consistent with your thinking, you might “unfriend” me, shun me, or even fire me, which is not good as we are also wired for self-preservation. And we are wired to avoid tension. Our brains use up more energy than any other organ in our bodies, accounting for only 2% of our weight but consuming 20% of our energy. You can see why, if we are excited or stressed, or if our emotions are “going” on any elevated level, we can end up feeling exhausted.
If I contemplate telling my friend, who is sitting across from my salad, that his bacon double-cheeseburger with extra mayo washed down with a diet cola is not exactly considered conscientious eating, he might just “unfriend” me, or he might fight back with “You heath nuts are fanatics!” He might go on, saying, “You take the fun out of eating and you eat boring stuff, so why not live a little? Here, have a fry!” This might get my fight-or-flight, social justice, truth, competitive spirit going. It also might hurt my relationship with reality, as I believe I am happier because my body feels better. I am also comforted based on the facts I have read that I will live longer and have fewer doctor and hospital visits as a result of my healthy lifestyle. All those thoughts, of course, run through my brain. Before I can form a reply to his initial response, he speaks an absolute truth that in his mind has relevance to our discussion: “We all are going to die anyway, so what does it matter what I eat?!”
Mohammad Ali knew well that “Every great plan changes when you get hit in the face.” And teenage pregnancy counselors know that all the facts, lectures, and pamphlets about STDs, pregnancy, self-image, and social standing become distant memories in the back seat of the quarterback’s car.
The reality is, however, that facts are facts, truth is truth – and “alternative truths” are neither truths nor facts. They are labeled and marketed as “truth” but are opinions, no different than how saying “We all are going to die” gets me to change the subject rather than continue to debate what really is conscientious eating.
The goal of this essay is to communicate to you, our valued clients, that we believe facts matter, that truth matters, and that through hard work, inquiry, and analysis of the scientific sort, our decisions will be better and the result will be good performance.
John Templeton was a great investor. He believed values mattered, not only because of his faith that “as you sow, so shall you reap,” but because values influence behavior, behavior influences lifestyle, lifestyle influences spending, and the result becomes economic units in the economy. He also believed that investors were rewarded for finding the truth, and for making decisions based on those truths. One of his guiding philosophies was “Investment opportunity is where perception is different than the truth.”
"Get your facts first then you can distort them as you please."
— Mark Twain
We know it might cost us friends, or even clients, to be rooted in facts and truth. But our work is to preserve our clients’ wealth, and to make it grow, and to do that we must stay in reality and not be guided by “alternative facts” or “truthiness,” or to be anchored in lazy habits that allow us to oversimplify the complex, interconnected, ever-changing world of investing. And, yes, one last thing: Humility aside, “I am smart, because my dad told me so.”
I am also happy to live in such interesting times...and that is the truth. And it might even be a fact.
For those who don’t know, at the end of each quarter, the FIM Group investment team conducts a webinar for clients. Our latest took place on January 25th, and a recorded version is archived on our website at http://fimg.net/media. This month, I thought I would go over the highlights of the webinar. These include a quick look back at 2016, a reminder about performance, and a few examples of how we are positioning accounts for the year ahead. Let’s get right to it.
Last year started off on a pretty rocky note. Fears related to China’s slowing economy and spillover effects from a slumping energy sector dominated market sentiment. Most commodity, stock, and high-yield bond markets faltered through February, but they eventually stabilized as low prices attracted value hunters. Things were then fairly quiet until late June, when British voters surprised the world with the “BREXIT” vote. Fooled by polls forecasting “BREMAIN,” traders quickly reacted to the news. The dollar shot higher and global stock markets buckled. So-called “safe haven” areas benefited, with gold hitting its highs for the year and U.S. Treasury bond yields hitting their lows. Within a few weeks, though, the mini-panic around BREXIT subsided, safe haven trades were halted, and global stock markets generally resumed their climb higher.
As we moved deeper into the second half of the year, global economic data started to look better, BREXIT’s immediate impacts were deemed manageable, and the Saudis signaled a change of tack on their oil production strategy of “pump until we put the shale frackers out of business.” Interest rates continued to normalize higher, putting pressure on yield-dependent assets like long-term bonds and utility stocks. The hike in U.S. interest rates also helped push the dollar higher, as foreigners traded in their currencies to buy relatively higher yielding U.S. securities.
Then, for many observers, the unthinkable happened and The Donald pulled off the second major “poll- busting” upset of the year. Anticipation of corporate tax cuts, deregulation, infrastructure spending, and a steeper yield curve (a larger spread between short- and long-term interest rates) caused another jolt to the dollar and a strong rally in financial sector stocks.
By year-end, despite quite the roller- coaster ride, almost every major asset class finished solidly in the black. Even the main performance laggards – longer-term U.S. government bonds and eurozone stocks – still managed to eke out modestly positive returns.
2016 was generally a solid year for FIM Group investment performance. Our patience paid off in the deep value areas that held performance back in 2015. These areas, including natural resources, real estate investment trusts (REITS), and fixed income closed-end funds, rallied strongly in the first half of the year. This rally allowed us to sell into strength and redirect some of this capital elsewhere.
In aggregate dollar terms, one of our largest areas of selling over the last few months was floating-rate, senior loan closed-end funds. Compared to midyear levels when we owned more than $60m worth of these funds, recent holdings are less than $10m (see figure below). The senior loan asset class performed well during the second half of the year on market expectations for an extended upcycle in the economy and continued low default rates. The closed-end funds that own these loans were very out of favor in early 2016. At that time, the world was bracing for an energy sector – led surge in bankruptcies. We were able to buy these funds at rare double-digit discounts to their underlying portfolio values, picking up additional return when the discounts normalized.
The cadence of FIM Group investment performance during the year also serves as a good reminder that our short-term results can vary quite significantly from the “market” returns reported in the financial media. As a general rule, we do not manage portfolios to track or beat a given “market” index. Instead, we aim to responsibly maintain and grow your portfolio’s after-inflation purchasing power over the long haul. This means that, much of the time, your portfolio will look and perform quite differently from what CNBC tells you “the market” did on any given day, quarter, or year.
To illustrate this, the figure below was built with 2016 data from a repre- sentative FIM-managed balanced strategy account (shown in blue) and the popular Vanguard Balanced Fund (VBINX, shown in red). VBINX is passively managed with a static 60% U.S. stock market/40% U.S. bond market mix. This illustration is not meant to represent your account’s monthly performance, but rather simply to show how our performance tends to come in “lumps” and will likely differ from “market” proxies. Again, our general investment objective is to generate long-term, positive absolute returns that protect and grow your wealth ahead of inflation. It is not to match/beat an arbitrary measure of the broad market.
Turning to this year, our team remains optimistic about our current portfolio holdings and vigilant toward mounting market risks. U.S. stock market valuations are quite high, and many bonds are still likely to return less than inflation for their holders in the years ahead. For example, nearly all U.S. stock market sector price-earnings ratios are now well above their long-term average levels (see figure on page 4). And in government- bond land, 30-year maturities in most major developed countries are still yielding less than 3% annually!
On the equity side of things, our team remains focused on companies positioned in off-the-radar growth niches and those offering underappreciated value situations. We seek stocks of companies with durable competitive advantages and proactive management teams intent on improving shareholder returns. The strong dollar, now at nearly 14-year highs, makes the relatively attractive valuations abroad even more compelling, and we continue to find good value in select inter- national holdings.
Three specific equity positions that fit these themes were discussed in our January 25th webinar. The first is Symphony International, a London- listed, Asia-focused holding company that recently announced a major share buyback. The second is Dream Office, a Canadian office REIT, which is taking advantage of the seller’s market for prime com- mercial property and doing something most REITs are disincentivized to do: shrinking its portfolio via property sales; we expect that proceeds from some of these sales will be returned to shareholders via dividends and buybacks. The third is U.K. bicycle and motor goods retailer Halfords, which recently announced a strong third-quarter trading update and a special dividend for shareholders.
As noted above on the fixed income side, we have sold much of the senior loan fund exposure we held in 2016. For now, we own a fairly large allocation to short- and medium-term U.S. Treasury bonds and are patiently seeking better return opportunities. Interest rates have gone back up significantly in recent months, so we are beginning to accept some incremental interest rate risk. We have been selectively adding a few preferred stocks and have modestly extended the average maturity of our longer-term government bond holdings.
Lately, there seems to be a growing narrative that the great, modern bull market in bonds, which began with the double-digit yields of the early Reagan years, will soon be officially over. The “bond gurus” preaching this view may be proved right, and a return to the far higher average yields (and lower bond prices) of the last four decades may soon be upon us. Yet history shows that a “lower for longer” interest rate outlook is not without precedent (see figure above). Indeed, sub-4% long-bond yields were the norm for most of the 100 years preceding the great 1970s bond bust. Today, a strong dollar, aging demo- graphics, and generally high debt levels are only a few of the factors that probably need to reverse before bond bears will really have reason to celebrate. Until they do, we think that even with rates near 40-year lows, there will still be opportunities in bond land for those willing to look.
I invite those of you interested in learning more about our investing process and strategies to check out our quarterly webinars. They usually run for no more than an hour, including time for us to answer client-submitted questions. And if you have topics of interest or questions for future webinars (and newsletters), please let us know. Your feedback and ideas are always much appreciated.
The long-running rule of thumb for a safe withdrawal rate from retirement portfolios is 4%, with most advisors arguing for 3%, 4%, or 5%. Using one constant rate for the long haul, however, ignores the reality of spending trends throughout retirement and may lead to unnecessary penny pinching in the early retirement years. In reality, annual spending levels are not constant. It seems that they actually decline over time at a pretty consistent rate for most retirees, which introduces some interesting nuances that can lead to a higher degree of confidence and, perhaps, higher, though still responsible, spending in the early years of retirement.
Over the past several years, research has uncovered this declining retirement spending phenomenon. Two studies seem to stick out: Estimating the True Cost of Retirement by David Blanchett, the Head of Retirement Research at Morn- ingstar, and Sudipto Banjeree’s Expendi- ture Patterns of Older Americans of the Employee Benefit Research Institute.
Both have very similar conclusions, well summarized by Blanchett’s assertion that real retirement spending rates decrease by 1% annually in the early years of retirement, 2% annually during the middle years, and 1% annually in the final years. (A graph of the Blanchett spending reduction rates looks like a smile, leading to the “Retirement Spending Smile” moniker.) The differ- ences in the rate of decline likely come primarily from the transition from the more active early retirement years – more travel and restaurants, perhaps a bigger housing footprint, and lower medical costs – to less active but still fairly healthy middle years. The final period of retirement, when the rate of spending declines slows again to 1%, experiences increased healthcare expenses. It’s important to note and reiterate that expenses in those early years and late years decline. They just decline at a slower rate than they do in the middle years. It’s also safe to assume that another factor affects the aggregate spending reduction throughout retirement: Some retirees overspend their assets in early retirement and, later have to drastically reduce expenses.
Because expenses are not a constant throughout retirement, this real decline over time can offset headier portfolio draws earlier on when retirees can enjoy it most. This isn’t an invitation to go hog wild! It would suggest, though, that veering from the generally accepted 4% rule for a number of years won’t lead to premature portfolio depletion and won’t, in most cases, restrict future optionality. It’s also important to be aware that averages do not describe individuals and that individual circumstances weigh greatly on determining optimal withdrawal rates in every financial plan. Active planning and regular reviews are paramount to ensuring successful retirements.
Dream Office REIT
(Tickers: D-U Toronto Exchange;
DRETF US Over the Counter,
Share Price/Market Capitalization:
Company Description: Dream Office REIT (Dream) is the largest “pure play” office REIT in Canada with a portfolio of 148 properties located predominately in Canada’s major urban centers.
Investment Thesis: Dream trades significantly below the market value of its net assets. Management is executing on a plan to stabilize net operating income and dispose of non-core properties. We expect that successful execution of this plan will lead to a reduced trading discount as well as continued high single-digit dividend yields.
Dream is a Canadian office REIT with more than $5b in properties across nine of Canada’s top ten office markets. The net operating income of its property portfolio splits roughly 40/40/20 between Greater Toronto/Western Canada/Eastern Canada. Occupancy currently runs around 88%.
Management has segmented Dream’s portfolio into three categories. Core Assets (47%) are prime, downtown buildings predominantly in Toronto and Montreal that will be retained and leased for stable and growing income. Private Market Assets (35%) are mostly in Toronto, Ottawa, and Vancouver. 60% of these are currently in the process of being sold. Value Added Assets (18%) are mostly in Alberta and are undergoing improvements before being brought to market for sale. As over $1b of Dream’s Private Market Assets are successfully sold, management will use proceeds to pay down debt and buy back stock. Any new growth initiatives are unlikely until later this year and will proceed only if there is a clear path to accretive NAV/share growth. Manage- ment also emphasizes sustainability as a core competitive advantage and leads a variety of ongoing environ- mental, social, and governance projects.
We expect that management’s plan will “prove” the value of its assets and provide flexibility to return value to shareholders. Management currently distributes a conservative 60% of its funds from operations (a cash flow metric typically used with REITs), which should allow it to maintain distribution levels even as the portfolio shrinks. Balance sheet debt is well distributed (weighted average maturity around four years), affording time for the disposal and value-enhancement programs to take place. We bought shares at more than a 20% discount to net asset value and expect this discount to close over time, driving double digit returns including a 7% annualized dividend.
444 Hana Hwy,
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Traverse City, MI 49684
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Onalaska, WI 54650