Investing for the long term has changed. Economic indicators and historical studies point to our being in, since October 2000, what is known as a Secular Bear Market. This means that a fundamental re-structuring is occurring, and until this process is complete, exuberance (irrational, or otherwise) will be hard to find. Instead of increasing profits and share prices, Secular Bear Markets bring decreasing profits and lower share prices as the normal market trend. Within this environment the markets sometimes do go up, but they are bucking a longer term trend where the rule of the day is financial defaults, deleveraging, and non-existent profits. It could almost be described as a “sideways” market-…volatile, but with no real progress because the real underlying story is Economic Restructuring. These are hard times for long term investors to bear, because opportunity seems to be presented only to tactical strategists taking large risks and trying to time the market.
There are investment opportunities in this kind of market… it just takes more work to uncover them, and more attention to trends as they play out in the evolving economy. The asset classes which are unfavorable in this kind of market are Stocks, Low Quality Bonds, Venture Capital, Leveraged Buyouts, Long-Bias equity strategies. The asset classes which are favorable in this environment are- Cash, High Quality Bonds, Gold, Long/Short Commodities, Managed Futures, Short Selling, and Short-Bias equity strategies.
Specially designed and monitored portfolio strategies have been implemented to recognize the markets for what they are, protect investor capital, and to make changes when appropriate. We have employed strategies designed to produce good “absolute” returns regardless of larger market behaviors, and to reward low volatility as the primary design requirement. The imperative for investing in Secular Bear markets is to avoid loss. Mathematically, it is so difficult to recover drastic losses, that successfully avoiding these losses can provide returns in excess of inflation, and returns which are competitive with stock indexes over the 15-25 years that a Secular Bear market typically lasts.
The core holding for all of our investors are primarily mutual funds employing this Low Volatility design. Alternative asset classes, conservatively-managed, bring advanced risk management to our investors similar to what Endowment Funds at Yale University have enjoyed. This new portfolio design has been tested over many years, and we consult with portfolio consultant and design author Lou Stanasolovich directly. Thus far in 2009, we have been pleased with the portfolio’s behavior during this very volatile stock market period since January.
Risk-seekers may co-subscribe to the Global Tactical Long Equity (GTLE) portfolio, which is not constrained by low risk requirements, and whose managers have been given broad license to seek growth wherever they find it, worldwide. GTLE is the “Alpha” portion of our allocation strategy, and is targeted at those investors seeking maximum growth while understanding the long time frame that may be required for this portion of the portfolio to bear fruit.
We at Russell Hawkes Associates believe that our primary directive is reducing the risks our clients face when investing in this uncertain economic climate. Our outlook is admittedly conservative and our approach cautious. However, we feel that the current Low Volatility asset mix is valid, and offers opportunities to grow assets while taking “the abyss” out of the realm of possibility. Everyone is different, but if you share our vision of responsible, absolute returns, and desire the objectivity of a fee-only relationship, then we may be just what you have been looking for.
There are several “absolute return” mutual funds in our portfolio. Absolute return strategies have a target rate of return of, say, 8%, that is stand-alone….it is not relative to an index… it is simply trying to achieve 8%, no matter what stocks or bonds or oil prices or corn prices or interest rates do during that time.
Absolute Return(AR) funds aim to reduce losses by playing the long, or bullish, side of the stock market, but also selling some shares short in case the market falls. This is sometimes also called Long/Short Equity Funds. Every fund manager develops a pricing forecast, and adjusts the “bias” his fund employs based on his/her forecast. In other words, is he devoting more resources to capturing upside, or protecting against downside? Their success during many market cycles earns them a place in our portfolio.
This approach is not a hedge fund, but it does mimic one. Mutual fund regulations demand transparency, prohibit leverage, and subject these types of funds to many more rules than the hedge funds. As you might imagine, this type of strategy, coupled with leverage, could greatly exaggerate the potential for gain and loss, and this is what real hedge funds are famous for doing. Not so in a publicly traded mutual fund.
Absolute Return funds are not new…they have been used by institutional investors for a long time. A 1997 SEC rule change prompted the retail launching of these funds. Fund giants Vanguard and Fidelity don’t currently offer them, but several institutional hedge funds have launched retail versions to attract a wider audience.
Absolute Return funds have a risk profile that is similar to bond funds, but unlike bond funds, the objective is a continuous positive return. Absolute Return strategies are actually less volatile than long term bonds, and have greater potential growth. It is these attributes which attract us as advisors, and why we feel this approach belongs in a diversified portfolio, especially in older investors, but really for anyone seeking a less volatile investing experience.
Investing in Absolute Return mutual funds requires that you do your homework. As with all mutual funds, a manager’s track record is important, as is the philosophy and outlook of the fund. Expenses, too, should be scrutinized. Although this category of investing does not carry exorbitant costs, it needs to be part the decision as to who manages this sector of your portfolio.
We have 8 funds that we have approved for portfolio use, and from January to June of this year, they have returned on average 5.26% . Not bad, considering the stock market has been extremely volatile and returned a little over 3% during the same time period. We are believers in Absolute Return investing, and forecast it will be part of our strategy for some time.
As Washington DC signs into law the American Recovery and Reinvestment Act, we all hope it will fix “the problem”, so we return to someplace we were, say, 1 year ago. That would be nice, right?
But is it realistic? I don’t think so. A recession in economic activity may not be a “problem” at all…it may be just reality setting in, finally. The huge bubble was not really a real estate bubble. It was a money bubble…mortgaged homes posing as wealth.It was “fake” money. Money whose value is not tied to current economic production, but is instead the spending of future production. The early to mid 2000′s witnessed HUGE amounts of worldwide capital flowing into our Wall Street-sizzled mortgage-backed debt obligations…as long as it said “mortgage backed”, the world bought ‘em!
So newly minted Main Street mortgage brokers (happy to trade in that pizza delivery job and armed with half-page applications), signed up everyone they could get their hands on for a new mortgage or a re-finance. Credit-happy consumers had a credit card payoff party, only to run ‘em up yet again. People with no business owning homes at these prices were moving in. Speculation was rampant, with people counting on 6 month turnarounds with 20% profits. See what I mean by “fake money”?
So returning to some “good old day” when the economy was stable and growth was “real” does not require a Stimulus Package, it requires an acknowledgment that reality is what is being presented, not a problem. The fact is, we began mortgaging our futures during the Johnson administration. We have bought (hook, line, and sinker) the premise that Keynesian economic theory is valid, and that levering economic activity is a valid long-term growth plan. Maybe it is, and the “money bubble” is just a bad thing that happens when borrowing is unregulated. And “unregulated” sure does describe the economic atmosphere since the Reagan administration, does it not?
So will this new ARRA bill provide the solutions to this problem? The problem, so we are told, is that the credit system is not flowing. So I guess we need more whiskey to help this hangover? It seems we are just another loan or two away from economic health, is that it? If we can just blow MORE hot air into the deflated balloon, we’ll all fly again.
Russell Hawkes Associates held a client meeting in the Decker Room at the Binghamton Public Library. We had a strong turnout, with over 100 clients turning out for information, reassurance, and to hear our forecast for the future of investing. Peyton Hawkes was the main speaker, and Russell Hawkes, firm founder, provided a welcome address.
The outline of the seminar was as follows:
1. What has happened to the economy and the financial markets?
2. What are some possible outcomes?
3. How have the managed portfolios changed in response to the crisis?
4. What is our outlook for the future, and how will the portfolios reflect this outlook?
5. Traditional vs Modular portfolio construction
1. What has happened to the economy and the financial markets? As of December 2008, virtually all assets classes have been pummeled, with the Dow, the S&P 500, and the NASDAQ all down in excess of 35% for the year. There was nowhere to hide, as even Intermediate Corp Bonds were down over 6%. So what happened? The US Real Estate market, and it’s overextended debt, were primarily to blame. Poorly underwritten mortgages were “securitized”, placed in complex financial notes, and sold as sound assets to banks all over the world. When interest rates reset, and defaults began piling up, bank balance sheets were reduced, and a crisis of confidence infected the banking system worldwide. A more fundamental problem is that American consumers, the primary engine for growth, are overextended and need to save more money and spend less.
2. What are some possible outcomes? The problems we face are quite daunting, and for the first time, reflect the global economy we are now living in. The worst case scenario is that the money supply increases and other stimulus measures will be ineffective, resulting in a worldwide depression. A more likely outcome is a recession, and that the economic setbacks will be buffered by the dramatic measures being taken by governments around the world to stimulate growth. In any case, it appears that capitalism itself has been called into question, and it is unlikely that America will enjoy the same leadership role in international affairs, given the turmoil we have created with our failed oversight and complex financial products. Some are calling this the nexus for a global power shift, where the United States enjoys less clout and a diminished economic stature from now on.
3. How have the managed portfolios changed in response to the crisis? We suffered, as an advisory firm, through a very difficult 3rd and 4th quarter in 2008. It was made particularly difficult as it became clear that this was a crisis unlike anything we, or any of our consultants, had ever seen. Our primary strategist, Litman-Gregory, initiated no less than 2 full allocation changes inside as many months. During this time, it became apparent that traditional portfolio assembly methods were failing us, and that we needed a fresh outlook. This was easier to decide upon than to implement, however, as the safety of all assets, even money markets, were being questioned. So we read and listened and watched the landscape take us to unimagined places, and were trying hard to find a place to put our client’s hard-earned nest eggs. We decided to divide our action into two phases: an initial reallocation to a very safe position, followed by a more sophisticated and complete portfolio allocation when we had decided what it should consist of.
6. What is our outlook for the future, and how will the portfolios reflect this outlook? It is impossible to know exactly what will happen after this financial tsunami, and every day a new wrinkle occurs. But we are going forward with some premises we think are sound. One theme we think will hold up is that the time has come to be less American-myopic in our investment policy. As a consumer-based economy without a significant manufacturing base, we feel growth is likely to occur outside the United States. More disturbing, we feel that the American dollar is at risk for decline versus other currencies. It is for this reason that our portfolios will contain non-dollar-denominated foreign stocks and bonds. Also, we feel that alternative energy, commodities, agriculture, and emerging markets will be leaders in providing returns to investors going forward.
7. Traditional vs Modular Portfolio Construction We consider Modular Portfolio Construction (MPC) to be the next evolution in portfolio design. Unlike the traditional Modern Portfolio Theory approach to portfolio design, MPC recognizes that investment policy can reflect thematic thinking, and that alternative asset classes can and should be used to provide more downside protection and increased diversification. Using MPC, we will be developing more sophisticated portfolios, divided up into three areas: Core holdings, Alpha holdings, and Alternative holdings.
(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.
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.
Peyton R. Hawkes
Russell Hawkes Associates Inc
The stock market does not reflect current economic conditions, but rather forecasts conditions, typically 6 months or more, into the future. So the stock market’s poor performance is indicative of what?
According to the National Bureau of Economic Research, a recession can be defined as
“a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches it’s trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.”
Looking back on the last 9 recessions (since 1953) provides valuable clues as to how this current one may play out.
- On average, recessions last 11 months. Stocks begin their descent 6 months earlier, and it lasts about 12 months, or into the middle of the recession. During this period the average return on stocks was a negative 21%.
- Then, as the markets discounts economic recovery, the returns turn positive, and the upward slope for stock prices averages a +36% return.
- Through the entire “recession cycle”, investors have averaged +8%.
The worst return, pre-recession to post-recession, since 1953, began in 2000, when the dot-com bubble burst, the 9/11 attacks occurred, and corporate accounting scandals were headlines.
Investors suffered a loss of 30% pre-to-post-recession, then in 2003 the they enjoyed a gain of 28.5% .
The next worst was Nov ’73 to March’75, a loss of 22%,during OPEC price-quadrupling, Watergate scandals, and Vietnam War spending.
From June 2007 through June of 2008, the S&P 500 has lost 18.25%. So we may have more time and further stock price reductions.
….Or not. The problem is that these things are not predictable. The economy is a model of complex pulleys, wheels, and levers. There are many possible outcomes.
But we do know that patient investors average 8% from pre to post-recession, on average, if they simply weather the full market cycle.
Well-allocated investors can reduce the peak-to-trough impact and “smooth the ride” by owning a sensible bond fund or ladder, which typically perform well when interest rates decline. Interest rate declines are common when stock prices are falling.
-Sources include: Jennison Dryden
Great Grandpa didn’t concern himself much with retirement. Odds are he wouldn’t live long past his employment years, and large, nearby extended family would insure his care if he did enjoy a long life.
Grandpa, on the other hand, was privy to the Social Security benefit, along with a strong American economy growing at a fast clip. Lots of opportunity came his way. A good work ethic, savings habits, and less temptation by the consumer credit trap, and he had himself a nest egg.
Now, Father’s generation had not only opportunity for the entrepreneurial among them, but also a paternal manufacturing industry that is almost quaint when pondered today. George F. Johnson’s plants and homes, the days when IBM had never laid off ANYONE , EVER. And these were the days of the Defined Benefit Pension Plan; if you worked for 30 years, a retirement income was guaranteed for life. The investing that was required to make this happen was the sole responsibility of The Company. Dad’s generation needed no investment savvy to make retirement happen.
Oh, how the landscape has changed. Today’s worker has changed jobs many times. He has re-tooled his skills several times to remain valuable. IBM has not only outsourced many jobs to India, but has cancelled that wonderful Defined Benefit Pension Plan his father enjoyed. EJ making shoes in America? Not in a long time, I’m afraid. For today’s worker, there are no guarantees ANYTHING will be there after 30 years in the workplace.
And what happened to that extended family Great Grandpa had? They have moved several times, and are all over the country, that’s what.
The onus falls on every Young Person to make the best use of the payroll-deducted savings opportunities that are available to them. That means never living on more than 85% of their income from the first day they begin working. That also means getting good investment returns. Making money in REAL terms: more than inflation and taxes will eat up. It isn’t the Fixed Option. They must get investment help, and it isn’t available at the water cooler either.
Young Person must also understand that the Credit World is poised to steal their prosperity, not provide it.
If you are a young person reading this article, or the Parent or Grandparent or Great Grandparent of a young worker, this means taking action NOW. Call a financial planner NOW and have him/her look at the 401(k) investment options and put together a portfolio that makes sense given your age. Find a planner who will do this for a fee, because there are no commissions available to do this. That’s why brokers aren’t calling you to do this. YOU must take action.
If you are within 10 years of wanting to retire, don’t forget that you are the Investment Manager of your Retirement Funds. Are you qualified? Paying attention? Reading? Nothing will be more important in your financial life once you stop working. Are you ready? I didn’t think so.
You need to pay a professional planner because IBM isn’t doing that for you anymore. You need to get good advice because you literally cannot afford to get this wrong.
Whether your 25, 45, 65, 0r 85, mapping out a strategy for your financial future is the task at hand. Consulting a fee-only financial consultant will bring to your circumstances the years of experience and perspective to do the job right. You need a professional in your corner who will respond appropriately as the world turns. Grandpa would be proud!
Peyton R. Hawkes
Russell Hawkes Associates, Inc