Indiana Jones and the Fountain of Wealth

With current markets swirling with questions of trade deals, recessions, inverted yield curves, and various other political and financial uncertainties, should we be fearing a near future “Temple of Doom” scenario like intrepid archaeologist Indiana Jones in the much acclaimed 1984 movie?!? Perhaps we can learn some tidbits of info – clues, per se – from Indy that can help us in our quest for our prized possession: financial serenity, wealth management’s version of the Holy Grail. While this ultimate goal may look a little different for each of us, and the journey this may be wildly different, some of the steps we take will likely be extremely similar, and the clues below, inspired by Indy, can provide some guidance as we take those steps!

Clue #1: Diversifying your arsenal, and your portfolio!

You’ve heard it before. In fact, diversification is a word that has been mentioned so many times in TV and movies that it’s become hard to think about investing without discussing how diversified one’s portfolio is. We’re here to tell you that this relationship makes sense! Various studies have shown over the years that having a well-diversified portfolio can significantly benefit investors in the long run.

Figure 1: Hypothetical Growth of $100,000 showing Diversified versus Undiversified Portfolio*

As shown in Figure 1, having a globally allocated, well-diversified portfolio made up of investments that have low correlation to one another, with pieces of each being from the equity, fixed income, and “nontraditional investments” (or alternatives), can help investors try to protect their assets during market downturns, and participate in market upswings. Much like Indy’s arsenal of guns, knives, and his famous whip protected him, using multiple asset class holdings with low correlations can protect investors’ portfolios from extreme danger.

Clue #2: Be Educated!

As a professor of archaeology at Marshall College, Indy’s extensive years of research have provided him a wealth of knowledge to work off of when he begins each search for ancient (and sometimes alien) artifacts. Despite this, he learns quite a bit along the way on his quests that leads to his success in discovering these items. Much like Indy, our pathways to financial health and peace often seem clouded in mystery, and are often filled with confusing directions and puzzles that can lead us astray from the path to our goals. These puzzles and directions, luckily, can be illuminated in most cases by educating one’s self in the complex and intricate business of finance! Whether it’s subjects of Arks, mysterious stones, or crystal skulls, a.k.a. topics of investments, insurance and taxes in finance terms, a little bit of knowledge can go a long way towards creating the ever important map to the desired goal! Blogs like these help our clients become educated and better prepared for the financial journey ahead!

Clue #3: A Little Help From Our Friends

No matter which adventure he’s on, Indy always has a crew of fellow explorers with him to help on his search. Each play their own integral role in supporting his journey as he brushes with Nazis, Russians, and Thuggee cults. In a similar manner, wealth managers like DWM can act as your “Short Round” (an ally) in your continual journey to financial serenity and success, helping guide you through the sometimes dark and perplexing pathways. Our expertise in these “ruins” of sorts can assist with dodging the pitfalls in your financial plans and portfolios.

With or without headlines coming out about recessions or inversions or trade deals or anything else, by following these three clues, and sticking to them for the long-term, an investor can create a stable pathway to success. Just as Indy never gives up on his quests, neither should we.  Our steps may alter in ways over our lives, from accumulating wealth, to protecting it, and then to financially planning for our legacies, but each of these has the underlying pursuit for peace of mind. Please feel free to reach out to DWM if you have any questions about how we can accompany you on your hunt.

*Source: https://www.schwab.com/resource-center/insights/content/why-global-diversification-matters

DWM 4Q18 & YEAR-END MARKET COMMENTARY

Fantasy Football and portfolio management may be more similar than one would think. Over the past weekend, I drafted a playoff fantasy football team which I’m hoping will amass more points than the other five “owners” in my league. Fantasy football drafting for both the regular season and playoffs is similar in that you want to take the NFL players that get the most touchdowns and the best stats in turn for rewarding you with higher points. The team with the most collective points wins! However, playoff fantasy drafting is much different than a regular season fantasy draft, with the key difference being one doesn’t know how many games that a player will actually play! Patrick Mahommes may be the best player available per game on paper; but if his KC Chiefs lose in their first game, a middle-of-the-road player like Julian Edelman from the Patriots who is expected to play multiple games, can be superior. Thus, the key is trying to pick not only the best available player, but also the one who will play the most games.

It’s sort of like investing, where picking NFL players and their teams become synonymous with picking companies. You want a collective bunch of players/securities that outperform others which ultimately leads to higher values. I looked at this draft pool of players like I would constructing a portfolio: diversifying my picks by player positions and teams.

Some of the other owners didn’t follow this disciplined approach, instead opting at throwing all of their marbles into the fate of one team and hoping it would lead them to the Fantasy Football Holy Land. And just like investing all or the majority of your dollars into one stock, this type of “coaching” can lead to utmost failure. Case in point: one owner loaded up on one team, taking several players on the Houston Texans. Ouch. (If you’re an NFL fan, you know that the Texans were squashed by the Colts and are out of the playoffs, just like this “owner” is now out of contention in our Fantasy League!) The morale of this story is: there is no silver bullet in football or investing; stay disciplined and diversified and reap the rewards over the long term.

And now onto the year-end market commentary…

Unfortunately, there were not many good draft picks this year. In fact, as stated in one of our previous blogs, around 90% of asset styles were in the red this year. And I don’t mean the Red Zone! Let’s see how the major asset classes fared in 4q18 and calendar year 2018:

Equities: Stocks were driving down the field, reaching record highs right before the 4th quarter began and then…well, let’s just say: “FUMBLE!” with the MSCI AC World Index & the S&P500 both dropping over 13%! This was the steepest annual decline for stocks since the financial crisis. Yes, investors were heavily penalized in 4Q18 for several infractions, the biggest being:

  • The slowing of economic growth
  • The ongoing withdrawal of monetary policy accommodation, i.e. the Fed raising rates and until recently, signaling more raises to come
  • Trade tensions continuing to escalate
  • The uncertainty of a prolonged US Government shut-down
  • Geopolitical risk

None of these risks above justify the severe market sell-off, which brought the MSCI AC World Index to a -10.2% return for 2018. This is in stark contrast to 2017, when it was up 24.0%! “Turnover!” Frankly, the stock market probably overdid it on the upside then and now has overdone it to the downside.

Fixed Income: The Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index “advanced the ball” in the fourth quarter, up 1.6% and 1.2%, respectively. Still, it wasn’t enough to produce any “first downs” with the US Agg essentially flat and the Barclays Global down 1.2% on the year. Bad play: In December, the Fed raised rates another quarter-point and indicated they may do more. Good play: within the last week, they may have completed the equivalent of a “Hail Mary” by signaling a much more dovish stance – it certainly made the stock market happy, now up 7 out of the last 9 days at the time of this writing.

Alternatives:  Like an ordinary offense playing against the mighty Chicago Bears D, alts were “sacked” in the fourth quarter as evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, falling 4.0% for the quarter and finishing the year down 5.1%. This is the worst showing ever for this alternative benchmark. Frankly, we are shocked with this draw-down, chalking it up to 2018 going down as the year where there was no place to hide. Gold*, Managed Futures**, and Merger Arbitrage*** proved to be good diversifiers in 4q18, up 7.5%, 3.6%, 2.4%, respectively; but not many “W’s” (aka “wins”) for the year in alts or any asset class for that matter.

Put it all together and a balanced investor is looking at negative single-digit percentage losses on the year. Yes, 2018, in particular the fourth quarter, was a brutal one for investors. It was like we were in the Red Zone about to score an exhilarating touchdown, only for a “Pick 6” to happen. (Pick 6 is when the football is intercepted and returned into the opposing end zone.) What we learned is that “L’s” (aka “losses”) or corrections can still happen. Going into this year, many had forgotten that markets actually can and do go down. Further, markets can be volatile, down big one day, and up big the next. So what is one to do now, besides putting the rally caps on?

The answer is: essentially nothing. Be disciplined and stay the course. Or, if your asset allocation mix has fallen far out-of-line of your long-term asset allocation target mix, you should rebalance back to target buying in relatively cheap areas and selling in relatively expensive areas. Or, if you happen to have come into cash recently, by all means put it to work into the stock market. This may not be the absolute bottom, but it sure appears to be a nice entry point after an almost 20% decline from top to bottom for most stock indices. From a valuation standpoint, equities haven’t looked this attractive in years, with valuations both here in the US and around the globe below the 25-year average.

And speaking of football, it’s easy to be a back-seat quarterback and say, “maybe we should’ve done something differently” before this latest correction. But we need to remember that empirical studies show that trying to time the market does NOT work. You have to make not just one good decision, but two: when to get out and when to get back in. By pulling an audible and being out of the market for just a few days, one can miss the best of all days as evidenced by the day after Christmas when the Dow Jones went up over 1000 points. In conclusion, if you can take the emotion out of it and stay fully invested through the ups and downs; at the end of your football career, you give yourself the best chance to make it to the Super Bowl.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the iShares Gold Trust

**represented by the Credit Suisse Managed Futures Strategy Fund

***represented by the Vivaldi Merger Arbitrage Fund

“Nowhere to Hide for Investors”

Nowhere-To-Hide_stock_market.png

Most years, financial markets are a mixed bag; some asset classes are up and some are down. Some years, like 2017, everything is up. And then there are years, like 2018, when everything is down. It’s been decades since stocks, bonds, commodities and gold all have reported negative results. Even though the American economy remains strong, with low unemployment and steady growth, expectations for the future have diminished. Rising trade tensions, a sharp slowdown in Chinese spending, rising interest rates and no additional tax reform have reduced the outlook for economic growth and corporate profits worldwide.

So, what’s an investor to do? We suggest you go back to the basics and review your financial and investment strategy for the future:

1)Determine how much risk you need to take on to meet your financial goals. What is the annual real rate of return you need to have enough money for your lifetime(s) and the legacy you wish to leave? When we say real return, we mean the nominal return less inflation. You, perhaps with help from your financial adviser, need to determine your expected investment portfolio at your time of “financial independence,” the annual amount you expect to withdraw from the portfolio to cover your needed and wanted expenses (any annual amount over 4% of the portfolio could be a problem), estimated inflation and estimated longevity. The calculation will produce a rate of return needed to meet your financial goals.

2)Next, determine how much risk you want to take on. Your “risk profile” is based on your risk capacity (your financial assets), your risk tolerance (your attitudes about risk), and your risk perception (your current feelings about risk). We’re all hard-wired with certain attitudes about risk. Some of us are aggressive and some of us are conservative or even defensive. Some of us are victims of the “recency bias,” which means that we think that whatever direction the markets have moved recently will continue (forever). At a minimum, we need to take on the risk we earlier determined necessary to meet our goals. If that seems too aggressive then we need to revise our financial goals downwards. If we want to take on more risk than is needed to reach our goals, that’s a personal choice.

3)Your risk profile should be based on the long-term, but may need to be adjusted. Once you, perhaps with help from your financial adviser, have determined you long-term risk profile as defensive, conservative, balanced, growth or aggressive, you should maintain that profile for the long-term and not move up or down due to short-term market conditions. Don’t try to time the markets’ ups and down. Staying invested for the long-term in an appropriate risk profile is your best strategy. However, life events can result in major changes in a person’s life. Death of a family member or loved one, marriage, relationship issues, changes in employment, illness and injury are all examples. At these times, your risk profile should be reviewed and, if appropriate, adjusted.

4)Determine an asset allocation based on your risk profile. There are three major asset classes; stocks (equity), bonds (fixed income), and alternatives (gold, real estate, etc.). Your risk profile will determine how much of your portfolio would be in each of these categories. A defensive investor would likely have little or no equity, substantial fixed income, and some alternatives. An aggressive investor could have most or all in equity, some or no fixed income and some or no alternatives. A balanced investor might have 50% equity, 25% fixed income and 25% alternatives.

5)Compare the real return you need to the asset allocation. Let’s use a balanced investor, for example. If equities have an expected net long-term return of 8-10%, fixed income 2-4%, and alternatives 2-4%, a balanced investor would have a hypothetical long-term net return of 6%. (9%x.5 + 3%x.25 +3%x.25). A 6% nominal return during times of 3% inflation produces a 3% real return. Compare this real return to your return needed in exercise one. A defensive investor who has no equities will be fortunate to have a hypothetical return equal to inflation. Someone who sits in cash will not even keep up with inflation. An aggressive investor, with all or mostly equities, will, over time, have the greatest return and will experience the greatest volatility. Aggressive is not for the faint of heart, aggressive investors generally lost 30-45% of their portfolio value in 2008.

6)Diversify your portfolio. After selecting your asset allocation, you need to look at your “investment styles” within each asset class. You should consider a global allocation for diversification. In 2018, while all equities are down, the S&P 500, led by Facebook, Apple, Netflix and Google, has been down the least. But, it doesn’t always work that way. The S&P 500 index was down 9.1% cumulatively from 2000-2009, while international stocks were up 17% cumulatively including emerging markets, which were up 154%. In the 11 decades starting in 1900 and ending in 2010, the US market outperformed the world market in 5 decades and underperformed in the other six. Consider perhaps having 20-30% of your equities in international holdings and make sure you have exposure to mid cap and small stocks domestically.

Conclusion: 2018 has been a tough year, particularly after 2017 was so good. We sometimes forget that even with the 10% and more corrections in the markets since October 1, equities have been up 7-10% per year, fixed income and alternatives up about 2% per year over the last three years ending this Monday, December 17th. If you need/want a real return above zero, you will likely need to invest in equities in some proportion. Determine how much risk you need/want and stick with it for the long-term, subject to life events changing it. Stay diversified and stay invested. Focus on what you can control, including enjoying the holiday season. Happy Holidays.

 

 

 

 

Building a Portfolio for Today’s Challenging Marketplace!

At DWM, our job is wealth management. We look to help our clients secure their financial futures through comprehensive financial planning and prudent investment management. Today, I’d like to focus on the investment management part which adheres to our philosophy of protection first, growth second.

Some readers may be familiar with DWM’s approach to investment management. At its core, it starts with the identification of our clients’ goals and constraints. We do this by identifying their goals, risk tolerance, return objectives, income needs, time horizon, and other special requirements. As every client is unique, so is each client portfolio.

We then match the characteristics of their goals and constraints with a specific Asset Allocation mix tailored to them. For example, x% equities via the DWM Core Equity Portfolio, y% fixed income via the DWM Core Fixed Income Portfolio, and z% alternatives via the DWM Liquid Alternatives Portfolio.

But many of our readers may not know the logistics of building those three DWM exclusive portfolios. Here is a little bit of the secret sauce:

The three major asset classes of equities, fixed income, and alternatives are further broken down into subclasses, which also have different exposures, risks, and potential returns. For example, we divide the equity portfolio into different sectors and market capitalizations, as well as between domestic and foreign stocks. We also pay attention to value vs growth. Then, in the fixed income portfolio, we split out exposure into government debt, corporate debt, and international debt, while paying special attention to credit risk and duration.

From there, there are several ways to go about choosing the securities to fulfill the subclasses. Our affiliation with Charles Schwab & Co- and its investment platform which makes most of the public investment universe available to us, there are lots of securities – some great, some not so great – to choose from.We further filter by looking at the following:

  • What type of exposure do we want to have in that subclass (for example, is market-cap weighted okay or is better to use a different methodology like factor-weighting)?
  • Total price to own and trade that security (e.g. the Operating Expense Ratio “OER” and ticket charge if applicable)
  • Volume: does the security trade enough for our firm to take a position for our clients’ portfolios
  • Security vehicle (ETF or Mutual Fund): both come with different characteristics
  • How do the securities complement one another, keeping in mind that non-correlating assets maximize your diversification benefits

It should be noted that from a risk management perspective we aren’t big fans of individual stocks. In fact, we began phasing out the use of individual stocks within our DWM-managed portfolios over a decade ago. Why?

  1. Company-specific risk: When allocating percentages of your portfolio to individual stocks, you run the possibility of the company represented by said stock going bankrupt or having a similar setback that can greatly increase the overall risk of your portfolio.
  2. More diversification with low-cost mutual funds and exchange-traded funds: With MFs and ETFs, we can incorporate the exposures to different individual stocks in one bundle, without having to have the aforementioned company-specific risk.

As you can now see, a lot goes into building and maintaining a portfolio. Once the initial portfolio is established with the appropriate weights to various investment style exposures, it is anything but “set and forget”. These “weights” or allocations to asset classes and the underlying investment styles can significantly fluctuate and will need to be rebalanced. Or we may find that we want more or less exposure to a specific area and thus adjustments are needed. Furthermore, new products – some great, some not so great – come to the market every day. If we identify one that is potentially a better fit to our model and it passes our due diligence process, we will make changes accordingly, whereby we execute trades via our sophisticated channels.

In conclusion, portfolio management is constantly evolving. Ongoing education and research is paramount to a solid investment management practice. At DWM, we don’t take that responsibility lightly. Through diligence and care, we seek to help our investors make their money work harder by eliminating the unforeseen landmines in their portfolio. Diversification, low-cost mutual funds/ETFs, and consistent portfolio monitoring are wonderful tools that DWM implements to help accomplish this hefty task, and keep our clients on track to meeting their financial goals.

Understanding Risk and Reward

Electronic Discovery Risk Assessment3-1024x664Mark Twain once said “There are three kinds of lies:  lies, damned lies and statistics”.  We are inundated nowadays with statistics.  Statistics are a scientific method for collecting and analyzing data in order to make some conclusion from them.  Very valuable indeed, though not a crystal ball by any means. 

When you study investment management, you must conquer the statistical formulas and concepts that attempt to measure portfolio risk in relation to the many variables that can affect one’s investment returns.  In the context of investing, higher returns are the reward for taking on this investment risk – there is a trade-off – the investments that usually provide the highest returns can also expose your portfolio to the largest potential losses.  On the other hand, more conservative investments will likely protect your principal, but also not grow it as much. 

Managing this risk is a fundamental responsibility for an investment advisor, like DWM.  You cannot eliminate investment risk. But two basic investment strategies can help manage both systemic risk (risk affecting the economy as a whole) and non-systemic risk (risks that affect a small part of the economy, or even a single company).

  • Asset Allocation. By including different asset classes in your portfolio (for example equities, fixed income, alternatives and cash), you increase the probability that some of your investments will provide satisfactory returns even if others are flat or losing value. Put another way, you’re reducing the risk of major losses that can result from over-emphasizing a single asset class, however resilient you might expect that class to be.
  • Diversification. When you diversify, you divide the money you’ve allocated to a particular asset class, such as equities, among asset styles of investments that belong to that asset class. Diversification, with its emphasis on variety, allows you to spread you assets around. In short, you don’t put all your investment eggs in one basket.

However, evaluating the best investment strategy for you personally is more subjective and can’t as easily be answered with statistics!  Investment advisors universally will try to quantify your willingness to lose money in your quest to achieve your goals. No one wants to lose money, but some investors may be willing and able to allow more risk in their portfolio, while others want to make sure they protect it as well as they can.  In other words, risk is the cost we accept for the chance to increase our returns.

At DWM, when our clients first come in, we ask them to complete a “risk tolerance questionnaire”.  This helps us understand some of the client’s feelings about investing, what their experiences have been in the past and what their expectations are for the future.  We also spend a considerable amount of time getting to know our clients and understanding what their goals are and what their current and future financial picture might look like.  With this information in mind, we can then establish an asset allocation for each client’s portfolio.  We customize the allocation to reflect what we know about them, looking at both their emotional tolerance for risk, as well as their financial capacity to take on that risk.  We also evaluate this risk tolerance level frequently to account for any changes to our clients’ feelings, aspirations or necessities.  While we use the risk tolerance questionnaire to start the conversation, it is our understanding of our client that allows us to fine tune the recommended allocation strategy.

A Wall Street Journal article challenged how clients feel about their own risk tolerance and suggested that being afraid of market volatility tends to keep investors in a misleading vacuum.  The article suggests that investors must also consider the risk of not meeting their goals and, that by taking this into account, the investor’s risk tolerance might be quite different.

The WSJ writer surveyed investors from 23 countries asking this question:

“Suppose that you are given an opportunity to replace your current portfolio with a new portfolio.  The new portfolio has a 50-50 chance to increase your standard of living by 50% during your lifetime.  However, the new portfolio also has a 50-50 chance to reduce your standard of living by X% during your lifetime.  What is the maximum % reduction in standard of living you are willing to accept?” Americans, on average, says the article, are willing to accept a 12.65% reduction in their standard of living for a 50-50 chance at a 50% increase.   How might you answer that question?

So, bottom line, it is the responsibility of your advisor, like DWM, to encourage you to choose a portfolio allocation based on reasonable expectations and goals.  However, understanding your own risk tolerance and seeing the big picture of your investment strategy is also your responsibility.  Our recommendations are intended to be held for the long-term and adhered to consistently through market up and downs.  We know that disciplined and diversified investing is the strategy that works best for every allocation!

We want all of our clients to have portfolios that give them the best chance to achieve their financial aspirations without risking large losses that might harm those chances.  Through risk tolerance tools and in-depth conversations, we get to know our clients very well, so we can help them make the right choice.  After all, our clients are not just numbers to us!

The Oracle’s Wager

When Warren Buffett, Chairman and CEO of Berkshire Hathaway Inc., discusses investing, most everyone in the financial industry pays attention.  No one can disagree with his success or business acumen and few seem to be better at picking stocks.  However, when Mr. Buffett criticized hedge funds back in 2007 for their heavy fees, one hedge fund manager decided to challenge him to an investment duel.  With a hefty bet of $500,000 on the line for charity, the wager was made to determine which strategy could perform better over a 10-year time frame – passive index funds or actively managed hedge fund strategies.  Articles in the WSJ and Fortune last week are spotlighting the performance battle, which will conclude at the end of 2017.  Mr. Buffett picked a low-cost S&P 500 index fund run by Vanguard and the former hedge fund manager, Ted Seides from Protégé Partners on Wall Street, chose five unnamed hedge funds.  While Mr. Seides agreed that over time the expenses from active management would eat into the returns to investors, he believed that an “unusually well-managed hedge fund portfolio” could be superior over time.

According to Fortune, who reports annually on the bet, the results, at this point, are not even close!  The index fund has recorded an annual increase of 7.1% for a total of 85.4% since the start of the bet.  The hedge fund has registered gains of an annual 2.2% or total average gains of 22%.  The discrepancies have been aided since 2007 by an extended bull market and poor hedge fund performance overall.  As Mr. Buffett states in his letter to his stockholders from February 25th, 2017, the performance average of the 5 hedge funds “were really dismal.”  Apparently, short of a complete market-meltdown, Girls Inc. of Omaha, Nebraska will get a nice contribution from Protégé Partners, thanks to Mr. Buffett.

As the WSJ points out, though, Mr. Buffett made his fortune by savvy investing in individual companies and undervalued stocks with his own brand of active management.  Not exactly a shining example for passive investing!  Mr. Buffett, also known as the Oracle of Omaha, releases an annual shareholders’ letter that is always highly anticipated.  One of his themes this year is passive investing versus active investing and his belief that “passive will beat active over time”.  Mr. Buffett has been critical in the past of investment managers for charging high management fees even when their funds underperform.  He encourages investors to use low-cost index funds and states in his letter from last week – “The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”  At DWM, we completely agree with Mr. Buffett on the benefits of passive vs. active investing for traditional asset classes like equities and fixed income.

However, here is where we see things differently.  Mr. Buffett is a billionaire and certainly has a monumental tolerance for risk.  Mr. Buffett has a history of making his fortune investing in exactly the companies included in this Vanguard index fund – the 500 top U.S. large-cap entities.  In contrast to the performance for the last 9+ years, had the bet occurred in the decade prior, Mr. Buffett would be the one on the losing end of the battle.  Since even the Oracle himself cannot predict how the market will perform going forward, at DWM, we believe in the low-cost benefit of passive index funds, but we also strongly believe in asset class and asset style diversification that will protect our clients who do not have the risk tolerance profile of Mr. Buffett.  We use index funds from several classes of equities, not just the S&P 500.  We use a diversified mix of domestic and international small and large cap funds.  We also use other asset classes to “hedge” our exposure to equities by using fixed income funds and alternatives.  We want to protect the assets of our clients, participating when the markets are up like in 2016, but protecting against downturns like in 2008.   A client portfolio with a balanced allocation might be a couple of percentage points below Mr. Buffett’s choice of index fund in various short term time periods, but our use of diversification instead of this concentrated investment style should lead to smoother returns, less downside, and ultimately better long-term results.

Mr. Buffett is an example of business leadership and financial prowess.  In his case, we think his advice to put your investments in low-cost and passive index funds is solid.  He is, however, an example of “do what I say, not what I do” in his investing style and we believe that trying to emulate the investing career of Warren Buffett should come with a warning label – don’t try this at home!  However, we applaud his advice on passive investments, but want to add that, unless you are a billionaire and can weather that amount of risk, diversification is critical to your success.  A strong mix of passive investments and diversification will do better over time.  You can bet on it!

DWM 3Q16 Market Commentary

wall-street-vs-main-streetWith all the uncertainty in the news today, a human being might emotionally feel quite anxious. If you hadn’t looked at your portfolio in a while, you may assume it’s not doing so great. But your portfolio does not have emotions and, if properly constructed, is capable of producing in all environments. In fact, if your portfolio did have emotions, it would probably be feeling quite happy as 2016 has so far been a pretty good year performance-wise, at least the portfolios we supervise. The thing is that Wall Street and Main Street don’t operate on the same level. Main Street may be feeling a little down, but Wall Street on the other hand may shrug off those fears and look at the opportunities. Or vice-versa. Case in point: The recent negative feelings of Main Street don’t resonate with the recent positive results stemming from Wall Street.

After a wild finish for stocks in 2q16 thanks to the surprising June 23rd Brexit vote, the US stock market calmed down and continued upward as represented by the S&P500 gaining 3.9% for the third quarter. Other equity markets did even better like small caps* and emerging markets**, both up 9.0%. Outside of equities, both fixed income and alternative markets generally charged ahead, adding to this upbeat 3q16 report.

Let’s start with the results of the major asset classes:

Equities: The MSCI AC World Equity Index registered +5.3% for the quarter and is now up 6.6% on the year. International small cap value***, up 10.5%, was one of the best places to be in the second quarter. That said, the stars of the year remain the mid cap space****, +12.1%, and emerging markets**, +16.0%. The S&P500 underperformance trend continues.

Fixed Income: The Barclays US Aggregate Bond Index, the most recognized bond benchmark, was up 0.5% in 3q16 and now up 5.8% for 2016. Unfortunately, that benchmark doesn’t allocate to the two hot spots in bond land this year: high yield bonds, +5.6% and 15.1%, quarter-to-date and YTD, respectively, and emerging markets debt, +4.8% and 16.6%. Hence, it is prudent to construct fixed income portfolios that contain more than treasury, investment-grade corporate, and agency exposure like the “Agg” and invest into other areas that can provide diversification and potentially better returns.

Alternatives: The Credit Suisse Liquid Alternative Beta Index was up 2.1% for the quarter and 3.2% YTD. Of course, one of the key benefits of alts is that they generally don’t trade in symphony with the rest of the market. But that doesn’t mean they necessarily will go down when equities and fixed income are up, like they were in this quarter. Alts beat to their own drum. What we think is important for our clients is designing an alternatives model with multiple non-correlated alternative assets and/or strategies that collectively produce consistent positive returns.

By looking at the above results and doing some simple math, we can theoretically see that an investor; with a balanced portfolio of, say 50% in equities, 25% fixed income, and 25% alternatives; could have overall net results of 6-8% YTD. And there’s still a quarter to go in 2016! Of course, nothing is guaranteed and there is certainly “uncertainty”. Whereas Wall Street may shrug off lots of things Main Street would not, here is the short list on what is keeping those traders up at night:

  1. The Election – this really is something that is causing more anxiety for Main Street than it is Wall Street. As crazy as it may seem, the market can actually see “good” in either of the major candidates. What the market doesn’t like is a surprise. If results came out opposite of the polls ala Brexit, it could get ugly, i.e. markets would trade lower. We don’t see that happening though.
  2. The European banking sector – Is Deutsche Bank with its thin capital issues the next Lehman Brothers? We don’t think so, but those banks all trade with one another and if one major bank fails, there can be a contagion effect that could even affect us on the other side of the globe.
  3. The economy – If you looked at the companies within the S&P500 and used that as a yardstick for the US economy, you might get a little alarmed to know that 3q16 will almost certainly be the sixth consecutive quarter of falling earnings. That hurts valuations now but we’re cautiously optimistic that that trend will end soon. When actual earnings (and estimates) start to rise, the market could continue to climb (even) higher.
  4. The Fed – What’s next for the Fed? There are two more meetings this year. We think one 25 basis points rate hike is already “baked” into the market. In other words, traders are expecting it. As long as the Fed keeps communicating clearly, they and their actions shouldn’t cause that much disruption.

In conclusion, Main Street is not Wall Street. For many, this Presidential Election is bringing a lot of unnecessary anxiety and we can certainly understand why. Of course, the market is generally efficient by constantly looking ahead at expectations and adjusts accordingly. Unless there are major surprises, it tends to shrug off news that can make Main Street nauseous. So if it’s getting to be too much for you, feel free to turn off the media noise and keep it off until November 9th, the day after the Election. Wall Street will keep doing its thing. More importantly, DWM will be doing its thing, keeping our clients’ portfolios prepared for what’s next.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the Russell 2000 Index
**represented by the MSCI Emerging Markets Index
***represented by the DFA Intl Small Cap Value Fund
****represented by the Dreyfus Mid Cap Index Fund
† represented by the Barclays Capital US Corporate High Yield Bond Index
‡ represented by the PowerShares Global Emerging Markets Sovereign Debt ETF

Election Musings

Trump ClintonAs the DNC convention concludes, we now have our two Presidential candidates and about 100 more days of campaigning before the Election on November 8th.  In a year of unprecedented dislike of both candidates, billions will be spent trying to convince voters.  What a waste.

The Supporters aren’t Changing.  Trump and Clinton supporters aren’t changing their minds.  One Trump enthusiast was asked what it would take for the Donald to lose his vote.  His response: “Nothing. There is nothing he could do to lose my vote.”  To his supporters, Donald Trump is going to make America great again.  “He’s rich and can’t be bought.” “He speaks his mind.” “He’ll get the job done.”  Those who oppose him often believe him to be a narcissistic buffoon, liar, racist, and woman-hater; unfit to be president.

Hillary Clinton’s supporters believe she is the only qualified candidate, the only one capable of being commander-in-chief and, of course, she isn’t Donald Trump.  Those who oppose her believe she is a phony, part of the establishment that caused their economic woes, and has a long history of corrupt episodes including the recent FBI investigation into the “extremely careless” use of her private email server.

For supporters, new information makes no difference.  “It really goes back asswards, lots of times,” said Peter Ditto, a psychologist at UC Irvine.  “People already have a firm opinion and that shapes the way they process information.”  Psychologists call this “motivated reasoning” meaning that once a person selects Trump or Clinton, they tend to downplay or ignore things that paint their candidate in a bad light by forcing new information to fit within pre-existing beliefs.  Even lies don’t matter.  Many people would rather hear an appealing fib rather than an ugly truth. And politicians know that for sure.

Investors like Clinton.  Americans with money in the markets prefer Clinton.  They love divided government and are assuming the Republicans will control Congress and Clinton would be held in check.  Actually, for all their promises of sweeping changes, U.S. Presidents can’t do much without the House and Senate.  Furthermore, Republican House Speaker Paul Ryan has his own ideas, different from Trump and Clinton on taxes, trade and other matters.  So, we’ll likely have a divided government in any case.

Wall Street seems to think that it is highly unlikely that Trump will win.  Of course, think back to Brexit, when the “Remain” camp was certain they wouldn’t lose.  If he did win, Trump would likely move quickly to get the U.S. out of NAFTA and perhaps put tariffs in place on Chinese and other goods.  This could lead to a “trade war” which would most likely hurt the U.S. and world economy.

The Race will likely remain too close to call.  With more than three months remaining, we will continue to be bombarded daily with media coverage, emails and phone calls.  Like Brexit, it will likely come down to voter turnout. There are many angry, disillusioned Americans these days.  They question is which ones will show up in droves on November 8th.

Impact on Investments.  When Britain voted to leave the EU it surprised investors worldwide.  In the U.S., markets initially declined 5-10% and many investors bailed out.  It took the markets just a few days to realize that Brexit is a UK problem, not a U.S. issue and since then the S&P 500 Index and Dow Jones have hit all-time highs though demand remains high for “haven” assets; for example, government bonds and gold.

Investing based on world events is nearly impossible. UK politicians, property owners, businesses and bookies got all it wrong.  Timing the market, both entrance and exits, is impossible.  Longer-term investors know that you need to look beyond short-term events like Brexit, Kennedy’s assassination, the 1987 market crash and 9/11 to see that each had a short-term downside and fear followed by a return to fundamentals.  It’s prudent to leave the short-term noise to short-term traders.

Let’s focus on staying invested in a globally diversified portfolio with an appropriate asset allocation.  Yes, diversification may be boring, but it works.  We can control our behavior, but there are lots of things we can’t control, including the U.S. Presidential election.  So, enjoy the Greek drama as it unfolds. Not sure we are watching a comedy, tragedy or satyr (featuring lustful, drunken woodland gods).   Regardless, don’t let it stress you out.  Enjoy the rest of the summer and focus on what you can control.

DWM 2Q16 Market Commentary

brett-blogWe’ve eclipsed the half way point of 2016; kids are out of school, people are gearing up for vacations, and temperatures are soaring. There are a couple more amazing things of note: 1) It’s July and the Cubs are still in 1st place! 2) Given all the uproar about everything from interest rates to oil to the election and to, most recently, Brexit; investor returns in general are not only positive, but pretty decent.

Think about it: we’ve been bombarded with negative news all year and the second quarter was no different. We had terrorism issues not only abroad, but here on American soil. We had job creation falter with May readings showing the worst month of employment gains since 2010. There’s economic weakness abundant around the globe. To top everything off, on June 23, we had Brexit – the UK referendum that shocked many when results showed more votes to actually LEAVE the European Union than remain! A sell-off in stocks ensued and had some feeling like it was 2008 all over again.

Well, it wasn’t. Markets reversed and many equity benchmarks are actually higher at this time of writing than they were before Brexit. (For more on Brexit, see our last week’s blog by clicking here.) In fact, in the US, the S&P 500 ended the week after Brexit up 3.3%, finishing the quarter with a 2.5% gain. In Europe, the EuroStoxx600 and the FTSE100 finished the week up 3.2% and 9.9%, respectively, in an apparent turnaround of investor confidence.

Investors also flocked to bonds during the quarter and even more so since the Brexit vote, with bond yields setting lows around the world. The Brexit vote actually helped solidify investors’ expectations for global central banks to keep rates down. And since yields move inversely to bond prices, bond investors did very well during this time period.

Let’s look at some numbers:

Fixed Income: The Barclays US Aggregate Bond Index, the most popular bond benchmark, was up 2.2% and now up 5.3% for 2016 – not many would have predicted that at the start of the year. Really almost everything within bond land did well. Corporates, in particular, did great as evidenced by the iBoxx USD Liquid Investment Grade Index registering 4.1% for the quarter & now up 9.0% YTD.

Equities: The MSCI AC World Equity Index registered +1.0% for the quarter and is now up 1.2% on the year. With the Brexit vote, European stocks struggled (MSCI Europe down 2.7% for the quarter & down 5.1% YTD), but emerging markets have done quite well with the MSCI Emerging Markets Index up 0.7% for the quarter and now up 6.4% YTD.  In terms of domestic cap style; in general, mid cap has outperformed small cap which has outperformed large cap. And value continues to outperform growth in a big way this year.

Alternatives: The Credit Suisse Liquid Alternative Beta Index aims to replicate the returns of the broad hedge fund universe using liquid securities.  It came in -0.7% for 2q16 thus indicating that those type of alternative strategies didn’t fare as well as some of the other alternative strategies we follow. For example, it was another stand-out quarter for gold* (+7%), real estate** (+3%), and MLPs*** (+19%). These alts are all up big YTD as well (24%, 9%, 11%; respectively).

So, a diversified investor with exposure to the three major asset classes may see returns somewhere between 3 and 5% for this first half of 2016 – 6-10% annualized – amongst all this so-called uncertainty.  Not bad!

We are also cautiously optimistic about the second half of 2016, however, the negativity and the uncertainty (CNBC’s word of the year so far) will definitely continue:

  • Brexit has really only started – this may take over two years to play out and even though Brexit fears have been shrugged off for now, they could come back. Clearly, European GDP and thus global GDP will be affected.
  • Central banks could be running out of ammunition if things do indeed get worse. Interest rates are NEGATIVE in Europe and Japan. How low can they go? And how much fire power really remains?
  • Here in the US, inflation remains well below the Fed’s 2% preferred target.
  • China growth problems and oil price volatility could resurface.
  • Profits at companies in S&P500 have fallen for four consecutive quarters and are expected to fall another 5% this quarter. Hard for stock prices to continue to go upward in that type of environment.

So, why be cautiously optimistic? There is some positive economic data out there including:

  • US consumer confidence is strong.
  • Retail sales continue to escalate steadily.
  • The Case-Shiller Home Price Index reported an April rise of 0.5%, with prices increasing on a seasonally adjusted basis in most cities.
  • There are pockets of strength to be found here in the US and around-the-world. Lots of exciting opportunities abound that keep hungry investors and companies enthusiastic!

Like we have said before, the key is to stay disciplined to your diversified game plan. Stay invested in accordance to a long-term asset allocation target mix which is in-line with your risk tolerance, and don’t let emotions control you. Unfortunately, that can be difficult to do on your own or if you have improper assistance.  On the other hand, if you have an independent, unbiased wealth manager like DWM, they can help you accomplish this by making the appropriate changes when and where necessary to lead you to the higher ground. Let us know if you have any questions on the way.

  • *represented by iShares Gold Trust
  • **represented by SPDR Dow Jones Global Real Estate
  • ***represented by Alerian MLP

Diversification vs. Chasing Performance: And the winner is…

2016-03-16 Annual Asset Class Performance1Our regular readers have come to expect an updated version of this “Asset Class Performance” chart about once a year.  (Click on it to enlarge.) It’s a little like running the Charleston’s Cooper River 10k Bridge Run once a year.  It puts things in perspective.  Things that go up, also go down.

Take a look at REITs in 2006 and 2007. From first to last in performance. And, Emerging Markets from 2007 to 2008, same thing. Bonds were almost a top to bottom in 2008 and 2009 and after Emerging Markets topped in 2009, it took them two years to hit bottom. Do we see a trend here?  Yes, we do.

As we discussed at our seminars in October, we’re all hard wired to want to jump on to winners and discard current losers.  We have a short memory – we place more emphasis on recent performance rather than long-term.  Furthermore, our emotions are aided and abetted by the media- always happy to make an up-and-comer sound like the perennial winner for decades to come and an asset class that is struggling to appear to have no hope of ever turning around.

We saw it earlier this year.  After a fairly dismal year of returns for all asset classes in 2015, 2016 stock markets got off to a slow start and then accelerated downward as pessimism, exacerbated by uncertainty in the world economy, interest rates, oil prices, U.S. Presidential politics and the media drove down performance until the second week in February.  And then, the pendulum starting swinging the other way, pushing markets upwards for the last four to five weeks.

A lot can happen in just a few years.  If we were looking at this same chart for the ten years ended December 31, 2013, the top performers were much different.   Emerging markets were the top performer, followed by mid caps, small caps, REITs, international stocks and then large caps.  Going back even farther, large caps for the ten year period 2000-2009 were negative.  Of course, they’ve come back strongly in the last five years, up 12% per year.

The key is that there is no “silver bullet”- that is, there is not one asset class that provides a simple and magical solution to asset allocation.  To illustrate this, let’s say we had decided to “chase performance” by investing 100% each year in the top performer of the prior year.  We can start with the results of 2006 and invest in REITs in 2007.  For 2008, we’ll invest in Emerging Markets, the top performer in 2007, and so forth for each of the next nine years.  The result: an annualized return of -4%.

Okay, how about if we invest in the most underperforming asset class instead.  We’ll invest in TIPS in 2007, REITs in 2008 and so forth. Our result is only slightly better, -3% annualized return.

Lastly, how about being a disciplined investor, using all asset classes and maintaining a balanced allocation, for example, of 50% equity, 35% fixed income, 10% REITs and 5% commodities for ten years?  The result:  An average annual return of 5.2%. With annual inflation at 1.6% for the decade, that’s quite a respectable real return of 3.6% per year for the last ten years.

The moral of the story is always the same.  Don’t follow your emotional biases.  Don’t chase performance.  Don’t try to time the market.  Instead, focus on what you can control:

  • Maintain an investment plan that fits your needs and risk tolerance
  • Identify an appropriate asset allocation target mix
  • Structure a diversified portfolio between and within asset classes
  • Reduce expenses and turnover
  • Minimize taxes
  • Rebalance regularly
  • Stay invested
  • Stay disciplined

If you have any questions or need any assistance with any of the above, please let us know.  At DWM, we’re ready to help and are passionate about adding value.