2017 April Newsletter

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

Theories, Diagnoses, and Actions

I miss my book Dictionary of Theories, which rests on a shelf at home. Years ago it sat, loved, on my bedside table. I enjoyed reading it, largely because it helped stretch my brain with quick summaries of theories from all sorts of disciplines, including those far outside the realms of economics and finance. If I could thumb through it here in Uganda, I wonder how many of the theories covered could help explain why we humans as a race have seemingly gone off the rails these days. How as a society we can create massive revolutions in technological progress and financial prosperity, yet simultaneously devolve when it comes to how we react to stress, uncertainty, and the general “tough times” that inevitably come with life and change. Or how in a world of such “convergence” we can still have so much disparity. I’m sure my trusty DOT could offer more than a few logical diagnoses that explain why our logical species still manages to act so illogically.

Why, Why, Why?

Seemingly illogical situations abound in the financial world, which makes this job so darn interesting. Not a day goes by when the word “why” hasn’t crossed my brain dozens if not hundreds of times. Why are markets so bullish on Trump policies that may be considered protectionist? Why are investors ignoring what seems like obvious value in a beaten-up Canadian company? Why such a massive share price reaction to a single quarterly earnings announcement? Why a multi-billion-dollar valuation for a company with no clear path to profitability? Why would an investor care about how they performed against an arbitrary index? And the list goes on.

As wealth managers, a key part of our mission here is to sift through these “why’s,” assess a wide range of situations, and ultimately take action for our clients. Thankfully, at FIM Group, we were designed from the get-go to operate in a way where we can do this indepen- dently, creatively, and collaboratively. Unlike many other firms with cultures centered on “managing money to meet or beat an index,” or “growing assets under management no matter what,” we can concentrate our investments where we think they can do the most good for our clients and offer unbiased financial advice. For example, we can hold cash, short-term government bonds, and money market instruments, or even gold, if we think stocks or long-dated bonds are “risky.” And we can encourage paying off mortgages, building up rainy day funds, or exploring a local community investment even if doing so means fewer assets for us to manage.

Non-Headline Risk

Today, I view FIM Group’s ability to independently assess market risks and opportunities and take appropriate actions as more important than ever. I see plenty of risks to navigate through, although the biggest ones are not necessarily those hogging recent headlines. For example, these days there is no shortage of reporting and analysis around President Trump’s trade and fiscal policy ideas. At face value, President Trump’s bias toward spending on tools of war rather than tools of peace (education-diplomacy-trade) are cause for concern. It is an illusion, simple- minded, shortsighted, even irrational to think that protectionism and government overspending are good for an economy over the long haul. While such policies may juice GDP and provide relief for less globally competitive companies in the short term, the long-term consequences could well prove opposite. Higher debt, higher prices for consumers, and weaker corporate competitiveness are all possibilities should our leadership fully embrace and implement some of President Trump’s more extreme ideas. My hunch is that the most controversial elements of his platform will get watered down (even by his own party) and take longer than he’d like to implement. But even if his ideas do manage to fast-track through our system of checks and balances, I feel comforted (on the investing side of things) by our team’s flexible, balanced approach to managing money and our current positioning that leaves us well prepared should markets react negatively to any policy surprises.

Passive ETF Investor: “Keep Those Tax Cuts and ETF Flows Coming!”

The more significant risk I see at the moment is simply the valuation levels of many popular (for U.S. investors) parts of the investment world. Most large U.S. company stocks (like those in the S&P 500 or the Dow Jones Industrial Average) look expensive by just about every measure. It seems that there are at least two major factors driving the continued move higher in valuations.

First, a high expectation that President Trump will be able to quickly implement his ideas for corporate taxes (including a broad tax cut and a tax holiday for foreign cash repatriation) and infrastructure investment. These moves are expected to juice corporate earnings per share as companies pay less in taxes and have more US$ cash available for corporate share buybacks. Generally speaking, stocks go up as expectations for earnings per share go up.

Second, there continues to be a surge in investor flows toward value-agnostic (or what I like to call “dumb”) U.S. stock exchange-traded funds (ETFs). These funds, which held more than $1.6 TRILLION in assets at the end of January, blindly buy all of the stocks in a given index (like the S&P 500), and this can lead to a temporary, virtuous cycle for stock markets. The blind buying by the ETFs helps provide tailwinds for the price appreciation of the overall market, which in turn attracts more investors to these products (away from managers who care about the quality and valuation of what they own), and more blind buying of the market. Should President Trump’s tax and infrastructure plans proceed more slowly and/or the rabid buying of U.S. stock ETFs fade, today’s high stock market valuation would likely face meaningful challenges.

Striking a Balance

Our team’s response to this challenge of high valuation in the U.S. stock market is to strike a balance. On the one hand we are staying invested in other, less expensive parts of global stock and bond markets (and yes, we are still finding compelling places to invest, especially those not being influenced by Trump- mania and ETF-driven buying). On the other hand, we are keeping ample dry powder to deploy when conditions change. We will stay disciplined on investment price and quality and only invest where and when we feel our clients will be rewarded to do so. In addition, we will continue to train and hone our skill sets so that we stay on the top of our game. I am blessed to be surrounded by super-smart professionals at FIM Group who work tirelessly so that we can effectively diagnose risks and oppor- tunities both in the investment realm and in the broader financial planning and client service areas.

We are a group of professionals who love investing, financial planning, and client service, who have been doing it a long time, and who collectively know one thing for certain: that investing and guiding clients successfully through life’s many financial decisions, over the long term, is hard work. We also have the training, temperament, experience, and humility to admit that even for us every day brings its challenges. True, it is fun, fulfilling, enjoyable work, but it is not simple.

Almost Fifty Years of Investing in the Books

As I write this, I just realized that in one hour and 24 minutes I turn 62 years old. I made my first investments at age 14, so I have been doing this for nearly five decades. What is interesting to me is that it remains challenging and interesting. Everything changes, so tomorrow night when I pull up to my desk (Kampala is eight hours ahead of New York, so I work late each night), after my kids sing “Happy Birthday” to me and I blow out the bonfire of candles, I will need to see the world afresh. I will continue to use my experience, contemplate others’ theories, look at history, analyze balance sheets, and consider products, competi tion, and management to value an investment to see if it is a quality, risk-adjusted bargain. My daughter Akasha will call from Costa Rica and we will chat about her work there, the environment, Trump, and her happy, fun, hippy, spiritual landlord. My son Keeston will also call, digging up some time from his 23 credit-hours college term, and want to chat about investments. He will stay on the phone talking investments till he has to go to class or I must get busy with my work. At the end he will say, “Oh, yeah. I just called to say, ‘Happy Birthday!’” Then there will be a pause and he will ask, “What do you think about the efficient market theory?” And then he might pause again and say, “Isn’t that the opposite of what you and Warren Buffett do, which is classic value investing?” And then, “Let me run my own theory by you,” which someday may very well appear in a future version of the DOT for his kids to read.

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

Ways to Avoid an Inheritance Disaster

“My children have always gotten along – I’m sure they’ll work it out!”

In my 20 years of assisting clients with financial planning, these words from the mouths of parents are all too common. Even those who do “all the right things,” and follow through with proper estate planning, believe that, because they’ve signed all the documents, it’s all taken care of and everything will work out. Unfortunately, unless you make careful preparations, even having the best inten- tions can create a potential disaster for your beloved, easygoing, adult children. Fortunately, there are important, yet rather simple, steps you can take to help the next generation deal with your pass- ing or that of your parents.

One step is to have open conversations about what you’d like to see happen regarding the family, the winter cabin, or that lovely condo on Maui. Too many times, the instructions to the successor simply read “divide it all between my chil- dren, equally.” But what if you promised Susan the heirloom china, and Thomas a valuable painting? The easiest solution is to write these bequests down and add them to your estate-planning documents. Especially if you have made direct prom- ises, I believe it’s safe to say that, unless you are crystal clear about who gets what, arguments are bound to happen.

A dear client of ours died last year. She was a feisty widow, well into her 90s, in great shape and very active. She also did everything right in keeping her estate planning and beneficiaries up to date and believed that, when it was her time, her heirs would “work the small stuff out.” Because my home on Maui hap- pened to be very close to hers, often

I would stop by after work to have her sign a form so she didn’t have to make the drive to our office. “Judith” (I’ve changed her name for anonymity) was always so gracious and very old- fashioned – she’d offer me a beverage and have goodies prepared on a tray, waiting for my arrival. It was never a short visit with Judith, yet I really enjoyed spending time with her. One afternoon, she was particularly talkative and asked if I had time to tour her lovely home – and of course I was delighted to do so. During the walk-through she’d stop here and there to show me a special heirloom, a meaningful portrait, pictures from her travels, and antiques she’d purchased over the years – all items she planned to bequeath to a specific child, grandchild, or great-grandchild. At the end of the history lesson (yes, she was a wonderful storyteller and every piece had a story), and knowing how diligent she was in her “planning,” I turned to her and said, “Judith, have you written this all down? As in, so everyone knows who gets what? Does your oldest son and sole Successor Trustee and Personal Representative of your estate know of these specific gifts and your wishes?” She turned to me with a puzzled look and replied, “No, I’ve never shared this with him...should I?”

I said, with great determination, “Absolutely!” I explained that if her goal was to be certain that her treasures were to be distributed as planned, she should write it all down and add the papers to her estate-planning documents. I said that doing so not only would make her son’s job of distributing her estate much easier, but also would make much less likely any animosity felt by family mem- bers who expected the “stuff” promised. She was highly appreciative of this ad- vice, and the following year, during her son’s visit, they spent an afternoon vid- eotaping and documenting every single piece, along with her verbal instructions. Following her passing, which occurred less than a year later, her son thanked me and said he was grateful they took the time to do this. Bequeathing certain items was important to Judith, and by be- ing specific and clear, they had avoided a potential disaster.I would venture to say that, like Judith, most people acquire valuable “stuff” over the years, and have a desire to bequeath certain items to designated beneficiaries. So, to avoid an inheritance disaster, and the potential breakup of a family, take time to prepare – get your estate-planning documents properly executed, your title assets de- tailed accordingly, your lists of beneficia- ries revised and updated when needed, but also your wishes documented as to specific bequests.

Hannon Armstrong

Summary Snapshot

Hannon Armstrong (Ticker: HASI)

Share Price/Market Capitalization:

Company Description: Hannon Arm- strong is a leading investor in sustainable infrastructure projects, including energy efficiency, solar, and wind.

Investment Thesis: An alternative energy-focused specialty finance company with large addressable opportunity, seasoned management, and business model flexibility to deliver above-average dividend growth in a wide variety of economic environments. We expect double-digit total returns from a >6% annualized dividend yield and share price appreciation as management executes on its long-term plan.

Hannon is a specialty financing company currently structured as a real estate investment trust (REIT). Unlike most REITs that own commercial buildings, Hannon lends money to a wide variety of investment grade borrowers that use the funds for alternative energy projects. These projects include those in the energy efficiency realm, such as upgrades to heating and cooling units, lighting, windows, and energy controls, as well as energy production projects in the solar and wind areas. Hannon is one of the pioneers in this space, having done its first renewable energy financing more than 25 years ago and its first energy efficiency financing deal 15 years ago. It is an industry leader in environmental disclosure and is internally managed with a long-term incentive plan that aligns well with shareholders.

The 40-person team at Hannon brings deep experience and connections to the niches in which it invests. This allows it to structure a wide range of deals for projects with complex regulatory issues and a broad scope of deal sizes (averaging about $11m per deal). Hannon partners with major alternative energy developers like First Solar; global energy service companies like Honeywell; and federal, state, and local units of government. Recent deals include financing for the U.S. Marine Corps (Parris Island base energy efficiency/production upgrades), two California school districts (distributed rooftop solar projects), and a Texas utility-scale alternative energy developer (120 MW wind farm). Its current portfolio of more than 130 investments, diversified by obligors, technologies, clients, and vendors, generates strong cash flows from preferred capital positions. This provides stability to its dividend as well as minimal exposure to commodity and resource variability.

Compared to its current $1.7 billion balance sheet, management has identified a $2.5 billion pipeline of prospective deals over the next 12 months. We believe that $1 billion of new deals is realistic over the next year, with similar scope in the years ahead, providing a solid backdrop for high single-digit percentage annual dividend growth. To date, Hannon’s team has used debt conservatively in its business model. Should it take debt to a more normal (that is, higher) level, we believe dividend growth could expand even further.

Market concerns surrounding the Trump administration’s support for alternative energy and the potential for higher rates seem to be two of the major factors behind Hannon’s attractive share price today. We believe that these concerns are more than priced into the company’s market valuations. The types of projects Hannon finances create jobs, reduce federal debt, and improve infrastructure, and, with only modest floating-rate debt exposure, any move higher in long-term interest rates should benefit the spreads that Hannon earns on future investments. Our initial purchases were made at prices that we believe can generate double-digit total returns. These returns should come from a 6.5% (and growing) dividend yield and share price appreciation, as management sustainably grows the business in the years ahead.


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