During my career I’ve had the privilege of meeting and working with brilliant people, and throughout my life I’ve profitably studied the elements of success. Not just “financial” success but the kind that leads to a happy, enjoyable, abundant life. Leo Buscaglia, a happiness expert, states: “Happiness is the relaxed enjoyment of life!” I have learned a lot from successful people I encountered, and a few of the attributes that seem to be consistent with sustainable success are flexibility, truth-seeking, virtue, and persistence toward continual improvement. Of course, this has to be layered over with humility, the ability to let go, and the willingness to embrace impermanence.
These practices are often hard for large enterprises to employ. When the iPhone 10 came out, did that mean the iPhone 7 was junk? No, the prior phones still had utility and worked fine. My wife, Amy, still prefers the 10-year-old Chrysler van to bus around our four boys, rather than our newer AWD Toyota van. Of course, “better” is always relative. When it comes to investing, “better” is being informed by the past, carrying forward the best time-tested wisdom and practices, but not being anchored or held back by what was. However, facts, history, and observation inform us that manias happen. Economics is about people in action. And people will speculate, while markets, economies, social movements, and accepted norms will always be cyclical, whether it be 1932, 1987, 2008, or 2018!
Scientific evidence has proven that to achieve excess investment returns (luck aside), a portfolio should contain securities that have a bias toward a few factors:
Value, which means you’ll want to own securities where the “price” you pay for the investment, based on its intrinsic value, is low. In other words, you’ll need to avoid overpaying for an investment – don’t buy into manias, and always stay disciplined.
Quality, which means that you ought to buy real businesses–not merely concepts, and certainly not companies with weak management, crummy balance sheets, or excess debt or companies located in too-crowded business areas.
Price always matters. So be disciplined and don’t buy $10.00 worth of value for $15.00, no matter what the Wall Street “experts” say. These experts are usually selling something or pumping things up to be sensational, or flacking some Facebook, Twitter, or email “research” promotions. And always investigate before you invest. We are all more time-starved than ever, but shortcuts in investing are never, ever worth the risk.
Size and geography also matter. Don’t constrain a portfolio by factors that will not help in the performance. Factors like the size of a company, its geographic footprint or headquarters or country of domicile, should not be limited by any external constraints that are irrational. Some restrictions are rational. For example, I lived in Africa for years, and most countries there have little protection for investors. But to say, “I’ll only make USA investments,” or “only 10% Europe” or “only 20% Asia” is just silly. That’s like saying you won’t buy food at Walmart, Costco, or a huge supermarket because its parking lot is too big. See the chart below.
Be willing to take some risks, however. Investing is not about gambling but rather is about being compensated for risks. Sometimes it’s logical to invest a small amount of your portfolio into a “Hero or Zero” risk. Years ago, for example, we at FIM Group owned Apple Computer’s corporate bonds, despite the fact that they were rated CCC, or “junk,” at the time. Nevertheless, I felt that Apple would “make it,” prosper, and surely pay off the bonds. I had clients and colleagues who strongly disagreed. Yet look at Apple today.
When we purchased Philippine Long Distance, as it went cheap during the time President Marcos was getting kicked out of the country and the Communists were parading in the streets with protest banners, I was told by clients and colleagues that the Philippines was “going Communist.” Fact is, in that country, with its 95% Catholic population and only 3% of Communists, no way would it ever become a country that nationalized its industries.
So what looks risky often is not, though we should always consider the perils of risk. That’s why FIM Group diversifies so that we avoid taking silly risks that would impair a client’s financial goals and plan.
While factors like value, quality, price, size, and geography are what create long-term investment success, the portfolio must nevertheless be constructed to do one thing: to accomplish the client’s goals. These could range from capital accumulation to income predictability to short-term capital preservation, among others. Naturally, all of this has to be consistent with the client’s tolerance for risk and volatility. For example, many of the clients reading this were our clients during the rough financial meltdown years of 2008/2009. Some were even clients during the goofy headwinds we had in 1987 and 1999 through 2002.
While market meltdowns like 2008/2009 are extremely rare, the key at such times is not to panic, but instead to let rationality prevail and have the portfolio constructed so that it can keep delivering during periods of downward volatility usually marked by fear. Going into the 2008/2009 period, we had portfolios lose value across the board, but our retired-income clients had their portfolios set up in such a way as to keep delivering income, regardless of how the portfolio value performed. As I’ve said before, “you want to live on the eggs, not the chicken.” Retirement portfolios, in short, are designed to grow over time, but the prime goal is to make sure the clients can have a stable income to stay retired.
With portfolios managed for growth, future retirement, or a capital-need event, one should embrace the fact that investment assets that tend to fluctuate (i.e., show volatility) tend to have the best long-term performance. It’s just common sense that, to get good long-term returns, you must embrace volatility as your friend. The chart above, is a bit complicated, but it basically points out that you will succeed when you invest wisely, scientifically, mathematically, and ultimately with common sense. In other words, if you look at a factor for only a year or so, you don’t get the benefit of letting long-term forces work out in your favor.
A little story: When living in Uganda, I developed severe asthma. The doctor gave me a wellness regime and also said, “stay out of the pollution, and avoid smoky fires and vehicle exhaust.” Even though I took that direction to heart right away, my symptoms didn’t go away for quite a while.
The lack of immediate progress, along with my medicine’s side effects, was discouraging, but as the doctor advised me and tinkered with my treatment, eventually I did get to where I had positive results. Now I have no residual effects—one reason is that the northern Michigan air here at FIM Group’s headquarters is really clean. Still, in Uganda, I had to be patient and not get discouraged when symptoms would go on for days. Just as we have to do when investing.
Like the economy, investments and markets are by definition cyclical. That’s as much a fact as is gravity. Knowing that allows us to be patient when it seems like we are doing everything right but not getting the expected results in the short term.
The bottom line is that a portfolio must be constructed to do a job, and then, of course, it needs to be monitored, managed, and patiently allowed to perform over time.
Once again, that festive time of year is upon us—that merry period following Thanksgiving when we decorate our trees, hang lights about our homes, and shop for loved ones as Mariah Carey’s “All I Want for Christmas Is You” stalks us during every waking moment. It’s a busy time of year, to be sure, which is why we—your wealth managers and financial advisors—are here to Grinch things up a bit by reminding you that there are only a few weeks left to implement year-end tax strategies. If you have any questions or would like assistance implementing any of the following, please contact your FIM Group advisor, because these are the sorts of moves that can improve your tax situation for 2018 and beyond. We can’t promise to have milk and cookies for you here at our offices, but the coffee will always be hot and our spirits bright!
• Make HSA contributions. Under Code Sec. 223(b)(8)(A), a calendar year taxpayer who is an eligible individual under the health savings account (HSA) rules for December 2018 is treated as having been an eligible individual for the entire year. Thus, an individual who first became eligible on, for example, December 1, 2018, may make a full year’s deductible, above-the-line con- tribution for 2018. If the individual makes that maximum contribution, he or she gets a deduction of $3,450 for individual coverage and $6,900 for family coverage (those age 55 or older are also eligible for an additional $1,000 catch-up).
• Apply a bunching strategy to deductible contributions and/or payments of medical expenses. Due to the increase of the standard deduction and the removal of many itemized deductions with the Tax Cuts & Jobs Act, many taxpayers who previously claimed itemized deductions will no longer be able to do so. However, a bunching strategy can help taxpayers circumvent this new reality. Essentially, the strategy amounts to accelerating or deferring discretionary medical expenses and/or charitable contributions into the year where a tax benefit can be projected.*
• Resolve any estimated tax underpayments. Employees may discover that their tax prepayments for 2018 have been too small because their estimates of income or deductions were off and they therefore withheld too little, or they failed to make estimated tax payments for unanticipated income such as gains from sales of stock, or they may be facing a penalty for underpayment of estimated tax because of the additional 0.9% Medicare tax and/or the 3.8% surtax on unearned income. Toward off or reduce an estimated tax under- payment penalty, employees can ask their employers to increase withholding for their last paycheck or paychecks to make up or reduce the deficiency. This is accomplished by filing a new Form W-4 or simply requesting that the employer withhold a flat amount of additional income tax.
Please note that increasing the final estimated tax payment for 2018 (due on January 15, 2019) can cut or eliminate the penalty for the underpayment of only the final quarter of the year. It will not help with underpayments for preceding quarters. By contrast, tax withheld on wages can wipe out or reduce underpayments for previous quarters because, as a general rule, an equal part of the total withholding during the year is treated as having been paid on each quarterly estimated payment date.
• Retirement plan distribution. An individual can take an eligible rollover distribution from a qualified retirement plan before the end of 2018 if he or she is facing a penalty for underpayment of estimated tax and if the increased withholding option described above is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution at a 20% rate and will be applied toward the taxes owed for 2018. The individual can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includable as income for 2018, but the withheld tax will be applied pro rata over the full 2018 tax year to reduce previous underpayments of estimated tax.*
• Don’t forget to take required minimum distributions (RMDs)! Taxpayers who have reached age 70½ should be sure to take their 2018 RMD from their IRAs, 401(k)s, or other employer-sponsored retirement plans. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Those who turned 70½ in 2018 can delay the first required distribution until 2019; however, taxpayers who take the deferral route will have to take a double distribution in 2019 (the amount required for 2018 plus the amount required for 2019). This strategy is particularly effective for taxpayers who anticipate they will be subject to a lower tax rate in 2019.
• Use IRAs to make charitable gifts. Taxpayers who have reached age 70½, own IRAs, and are thinking of making a charitable gift should consider arranging for the gift to be made by way of a qualified charitable distribution (QCD). A QCD is a direct transfer from the IRA trustee to the charitable organization. Such a transfer (not to exceed $100,000) will neither be included in gross income nor allowed as a deduction on the taxpayer’s return. But, since such a distribution is not includable as gross income, it will not increase adjusted gross income (AGI) for the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches a certain specified level.
Making a qualified charitable contribution before year-end is a particularly good idea for retired taxpayers who don’t need all of their as-yet-undistributed RMD for living expenses. That’s because a charitable contribution distribution reduces the amount of the RMD that must be withdrawn, resulting in tax savings.*
• Make year-end gifts. An individual can give any other person up to $15,000 in 2018 without incurring any gift tax. The annual exclusion amount increases to $30,000 per donee if the donor’s spouse consents to gift splitting. Anyone anticipating a potential estate tax liability who can afford to make gifts to family members should do so. In addition to avoiding transfer tax, annual exclusion gifts take the appreciation of future gift/inheritance assets out of the donor’s estate and shift the income tax obligation on any earnings to the donee, who will ideally be in a lower tax bracket. Note that the “Kiddie Tax,” among other factors, can throw a wrench into this benefit, so it’s vital to discuss this strategy with your FIM Group advisor ahead of time.*
*Your FIM Group advisor can model these for you!
(Ticker: PRGAF Website: www.pargesa.ch)
Share Price/Market Capitalization: Sfr 70.40/US$6b
Investment thesis: Pargesa is a listed Swiss holding company controlled by two families with a long history of value-investing success. We believe its shares trade at an unusually wide discount to the company’s net asset value (NAV), which is primarily composed of Europe-listed, globally focused, blue-chip companies.
Pargesa is a family-controlled holding company that owns a concentrated portfolio of listed European companies as well as stakes in several private equity funds. Its investment team generally maintains a high-quality, growth-at-a-reasonable-price investment philosophy, and it acquires stakes in companies where it can exert control or major influence. Responsible management is viewed as essential for long-term profitability, and environmental, social, and governance issues are incorporated into its active ownership approach. Its key objectives for shareholders are a growing stream of dividend payments and long-term portfolio value growth.
Over the last few years, Pargesa’s management has rebalanced the portfolio to be less yield-oriented and more focused on growth and total return. Heavy exposures to energy and utility companies were significantly reduced, while a mix of industrial, business service, and consumer goods companies were introduced into the portfolio. Its investment team looks for sector-leading companies with solid business models, high-quality management teams, and sound financial structures.
Pargesa’s portfolio consists primarily of Europe-listed stocks whose companies’ operations span the globe. Its top-five holdings, making up over 70% of the portfolio value, are the sportswear company Adidas, beverage producer Pernod Ricard, inspection and verifications services provider SGS, cement and aggregates manufacturer LafargeHolcim, and specialty chemicals maker Imerys.
With negative sentiment driving European stock markets lower this year, valuations have again become attractive. This is true both at the underlying holding level and with Pargesa itself, which now trades at one of the largest discounts to net asset value we’ve seen in the last two decades. We recently added to our position in appropriate client accounts after trimming earlier in the year. Our expected returns should come from a 3% dividend yield, long-term earnings growth at the underlying holdings, and a “double re-rating” at both the portfolio company and holding company levels.
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