(An open letter to our clients during the September 2008 credit crisis)
The credit crisis of 2008 is one of the most acute financial problems the world has ever faced. Essentially, borrowers signed mortgage notes without adequate pre-qualifying, and the terms of these notes provided “resets” which dramatically increased the required payment, leaving many borrowers unable to make the payments. To make matters worse, housing values dropped dramatically, causing many borrowers to simply walk away from their obligation.
These mortgage notes were packaged into complicated income vehicles, and the rating agencies failed to accurately disclose the risks inherent in these notes, which was really a product of the conflicts of interest these rating agencies had when providing the disclosure to investors. Most of the investors in these notes were financial firms, who included in their financial statements the assumed full value of the notes. Oh, and this not just a domestic problem…these notes were purchased world-wide. It is astounding the number of CEO’s and CFO’s who failed to recognize (chose to ignore?) the true risk of these notes. Now that the notes are failing, the revision of financial statements has caused a dramatic revaluation, causing stock prices of these financial firms to plummet, and affecting other companies and industries stock issues at the same time.
So what does the future hold for our credit and monetary systems? It is not an easy question to answer. Because these complex mortgage notes are the root of the problem, it is very difficult to assess the risks that still remain. One thing is for sure, this crisis will leave fewer financial companies in it’s wake, as mergers are completed. We are concerned that the liquidity and credit crisis may very well become a more widespread economic crisis. Cross your fingers this does not happen.
The Russell Hawkes Fee Only Portfolios are faring quite well. Diversification and our disciplined portfolio-building techniques are producing less volatility than a more focused (or “tactical”) strategy.
Also, our mutual fund managers are paired with one another because of their differing investment styles, adding another layer of diversification. Our decision to add the Amana Growth Fund in early 2007 has been a real success story. Amana invests according to the principles of Islamic Law, which prohibits profiting from lending. We chose this in order to limit our exposure to the financial sector, and this has obviously been a big advantage to the portfolios and for our clients.
The PIMCO Total Return and Emerging Markets bond funds, along with the Loomis Sayles Bond Fund, have been a bright spot compared to equities. Our bond fund managers have shown discipline. Seeing little value in the bond markets, they have been unafraid to take heavy cash positions. This has been a smart play. Signs of inflation are detrimental to bond holdings, so we anticipate that bonds and their inherent interest rate sensitivity could be less of a safe haven than usual in this phase of a receding economy.
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To give you an idea of how the Sept 15th, 500+ point drop in the Dow affected our portfolios, let’s look at exactly what happened. In one day, the DJIA dropped more than 4.5% in value. Our most aggressive Equity portfolio dropped only 3.81%, our Equity-Tilted dropped 3.04%, our Balanced dropped 2.46%, and our Conservative portfolio dropped only 1.52%.
So what would we recommend you do for the future? It is our feeling that the current financial crisis may have very serious implications for the next 12 months or more. We believe it will be resolved, but that there is no easy fix for this deep rooted problem.
Our portfolios contain mutual funds which have been screened for both bull and bear market superiority. Their investing style attracted us because they tend to be as conscious of avoiding losses as achieving gains. That’s why they are in our portfolios…risk and return characteristics which outpace their peers. In these turbulent times, it’s important to let them do their work….they are busy plucking good value from these ugly markets. It is during these low points that great companies are cheap to buy.
Even still, there may be those of you who, psychologically, cannot weather this financial storm. If you are feeling this way, you may want to consider our Conservative Balanced Portfolio.
The Conservative Balanced Portfolio is structured to be basically 60% Bonds and 40% diversified stocks, most of which are dividend-paying. We do not expect the stock portion to contribute much growth to the portfolio in the near term. We expect it’s price will bounce around, it will pay it’s dividends, but not add real octane to the portfolio until the current crisis has been resolved. The bond portion of the portfolio, whose managers are quite cash-laden at the moment, will also produce an income stream for investors. The bottom line is a portfolio strategy that is cash-heavy (currently over 44% cash!), and produces annual dividends of about 3.46%.This portfolio strategy provides prudent exposure to stocks for long term growth, but with enough bonds, cash, and dividend-producing stocks to generate an immediate income stream. Over time, the stock market will recover. In the meantime, our top-quality stock and bond fund managers are searching for the opportunities this crisis presents, and making wise purchase decisions for the future. Patient investors will be rewarded for their grit during these difficult times.
As always, Russell Hawkes Associates values your business, and takes seriously our role as your trusted advisor through good and bad markets.
Yours Truly
Peyton R. Hawkes
Russell Hawkes Associates Inc
