Past Performance Does Not Guarantee Future Results --
Investment Involves Risk
We are often asked by potential clients questions such as “What are your historical returns?” and “What products do you think are best?”
We will attempt to answer those questions as well as give our clients insight into our current investment philosophy.
To make this discussion easy to follow, we have divided it into four parts. First, we’ll begin with a discussion on risk, followed by investment philosophy which will include possible investment tools used. We will then turn our attention to implementation of the strategy and finally, we will conclude with a brief discussion of comprehensive reviews.
“Only those who will risk going too far can possibly find out how far one can go” T.S. Elliot
Risk is that dirty little four letter word which no one wants to talk about. So you know us—we lead with it. From www.Merriam-Webster.com one can find risk defined as (1) Possibility of loss or injury, or (2) The chance an investment will lose value. Now let’s take a moment to break down this last definition a little further:
Chance- Something that happens unpredictably
Investment – outlay of money usually in an attempt for income or profit
Lose – undergo deprivation of something of value
Value – relative worth, utility, or importance
The point here is that risk is complicated. Over the years, we have seen many academics and salesmen attempt to shorten the definition of risk by equating it to volatility. They have fancy labels like alpha, beta, and Sharpe ratios to make the rest of us say “Gee, they are smart…they must be right!” After years of hard lessons we know that risk is more than just volatility and that anyone who guarantees or attempts to suggest they can predict the future based on historical price movements is simply wrong.
The other point we can gather from the definitions above is that ALL INVESTING INVOLVES RISK. This is true regardless of whether you see the volatility or not. We have come to believe that the best investors are not looking for a “no risk” strategy or a “free lunch”. Instead, they are searching for places where they believe they know the major risks and the market has priced that risk too high, which corresponds to a lower nominal price. With this thought in mind we now want to share with you our current assessment of how to approach the risk of outlaying one’s money.
“One’s philosophy is not best expressed in words; it is expressed in the choices one makes… and the choices we make are ultimately our responsibility” Eleanor Roosevelt
Our investment philosophy is an approach to search for what we believe is investment value. Often during this pursuit we search for places we believe risk has been over-priced by the markets, allowing us to side with positions and thoughts which are independent, and often times contrary to current, popular opinion. We believe that at certain times the market price will not properly reflect the underlying risk of an investment. This means that our philosophy uses analysis over prediction. To follow through, we think it is important to have a patient mindset and an understanding that there will generally be a variety of risk factors that play out within a given portfolio. To analyze these risk factors, we begin by gathering a client's desired target allocation in three main areas:
1. Short-term fixed maturity (money market, CDs, bonds, and fixed maturity from 0 - 18 months)
2. Mid-term fixed maturity (CDs, bonds, fixed maturity from 19 - 60 months)
3. Open-ended eligible investment strategies (bonds, preferred stocks, common stocks, closed-end funds, ETF’s, REITS, oil trusts, etc.)
From there, we work to meet the target allocations. In describing this philosophy further, we tend to find it easier to turn the investment problem on its head. The majority of popular press concerns the entry of a position and we find it easier to differentiate risk by describing how one anticipates exiting the position. Short term and mid-term investments are usually determined by the client’s cash flow needs and risk tolerance. For purposes of description we have broken the open-ended investment strategies into four general, non-binding categories:
3a. Timed event – this is when a known future event is likely to provide liquidity. Examples include merger arbitrage and deep covered call writing.
3b. Non-specific timed event – this is where liquidation of some type is expected but the timing is currently unknown, yet we believe would be above the current price if it occurred in the not too distant future (maybe three to seven years). Examples include closed-end funds at wide discounts to the net asset value, common stocks/bonds below book value with positive cash flow, and common stocks below networking capital.
3c. Non-event driven – this is an open ended category in which we look for value in stocks of companies that are:
i. generally out of favor and we believe the company has a competitive advantage which may allow profits to grow; or
ii. specifically out of favor with reasonable or no debts, high historical profitability and in need of some type of transition.
3d. Contrarian asset allocation - this strategy involves allocating assets to the two most contrarian asset classes, by using low cost etf’s. We created our own ranking system to determine longer term out of favor positions.
This philosophy description is intended to share our thoughts with clients, future clients, and other investment advisors. This describes how we are attempting to manage portfolios at this time, yet we understand markets are constantly changing and require investment strategies to change as well. As such, this philosophy will likely not fit every person at every point in time, and does not intend to give the impression that categories listed above are all-inclusive or mutually exclusive. For these reasons, and as philosophies and strategies evolve, we will seek to update you in the form of mass communications and scheduled personal reviews. As always, past performance does not guarantee future results and the strategy above does have risk of principal loss among other risks.
Implementation of Strategy
“A satisfied customer is the best business strategy of all” Michael LeBoeuf
When considering how a strategy is implemented, we must refer back to the section above regarding the three main target allocation areas. In our initial strategy meeting, new clients choose their target allocations to short-term fixed maturity, mid-term fixed maturity, and eligible investment strategies. This is done prior to any investing. Staying true to a value mindset, we do not want to rush to meet all targets at once. This would give clients results based more on the luck or randomness of when they decided to become a client rather than any skill or analysis we may contribute. Analyzing each portfolio independently leads to “no two portfolios to be exactly alike”. Even though this is more difficult and less efficient than the “cookie-cutter” approach taken by pooled money such as mutual funds and variable annuities, we believe the time we invest will be rewarded in higher client satisfaction over the long term.
That brings us to answering the first two questions. First, we do not give or publish historical returns because each client’s portfolio is different based on when they became a client and risk tolerance; among other things. The answer to the second is we do not sell “products” because we do not believe that one product could solve all risks. As investors, we believe it is best to implement a constantly changing process when attempting to deal with the uncertainty of risk.
“Feedback is the breakfast of champions” Ken Blanchard
One may now correctly ask “What good does all that do if you do not review it?” This is precisely why we meet with our clients and perform comprehensive reviews. In these meetings we are looking to review performance and find out if any changes should be made from the clients end. We ask questions regarding changes to personal information (phone numbers, address, etc), beneficiary choices, meeting frequency, health, taxes (such as expected income or deductions), Social Security, estate planning, target allocation changes due to risk tolerance and anticipated withdrawal changes. These questions help us to understand your unique situation.
We typically find the frequency of meetings to be higher in the early stages as clients are learning new topics. Meetings can be conducted face to face, via net meeting, or phone conferences – whichever the client prefers.
Contact us today to learn more about our personalized investment services.