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Dear Valued Client,
At some point, I'll be able to send out a newsletter of note that focuses on something other than market performance. We're not there yet, unfortunately, as more grim economic news and some ham-handed moves by the government have driven the market downward. Given these recent declines, I thought it would be useful to provide a high level overview of how most portfolios are positioned, and you'll find this overview in the first column below.
This month's client question also focuses on the markets, and specifically why markets would continue to decline below fair value. Lastly, in this month's financial planning tip we focus on something other than the markets in looking at the role of the Public Utility Commission, and how they might be able to help out should you run into a problem with a regulated utility you can't resolve yourself.
With all that's gone on in the past few weeks, it's easy to forget that Thanksgiving is just around the corner. We're headed north to Pittsburgh, to visit Jennifer's family and to enjoy a few days' rest. We hope you and yours enjoy a peaceful, happy Thanksgiving as well.
Sincerely,
Micah Porter, CFA
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Portfolio Positioning During the Downturn
Micah Porter, CFA
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One of the primary differences in our mind between a wealth manager - which we are- and a money manager is that money managers manage to a specific mandate. The mandate may be to invest in large cap stocks and to beat the S&P 500, or to seek out opportunities in distressed companies and maximize return. Every client’s portfolio is identical or nearly so, input from clients as to their investments is minimal or non-existent, and the manager’s overriding concern is carrying out his or her mandate.
Wealth managers, on the other hand, are focused on ensuring clients meet their financial goals. Goals differ, and thus, portfolios differ. Further, via their investment policy statement - which we believe is critical - clients have input into the composition of their portfolios, based on personal preferences, tax situation and the like. Nevertheless, most portfolios share certain investments and characteristics, and given ongoing market turmoil, we thought it would be useful to provide an overview of how we have portfolios positioned generally, and what our expectations are moving forward.
We split portfolio positions into a few different categories, which are cash and short-term CDs, fixed income and equities. Our positioning and expectation for each category is as follows:
Cash and short-term CDs - nearly every portfolio we manage is overweight cash, typically by 8% or more, and we made the decision to overweight cash in portfolios in late September. When we overweighted cash, our plan was to begin to put this cash back to work, as opportunities arose, but with an eye towards limiting risk when doing so. In the past two weeks, we’ve begun to invest a bit of the excess cash in some portfolios in fixed income funds that we believe are well positioned to provide solid returns once markets stabilize.
For clients who need cash from their portfolio, we have generally set aside a sufficient amount in both money market and short term CDs to fund several years worth of cash needs. Unless this downturn is unprecedented in length, what we’ve set aside should allow clients to weather the downturn without being forced to sell stocks to raise cash.
Fixed Income - aside from short-term CDs, which we view as sources of liquidity for clients who need to withdraw from their portfolios, we use bond funds for fixed income exposure. We divide those funds into three categories, as follows:
- Conservative - funds in the conservative category are meant to hold their value, and provide returns in typical markets comparable to, but ideally a bit better than, CDs. We use both taxable and tax free funds in this category. Funds used include PIMCO Limited Duration, Vanguard Limited Term Tax Exempt and the TIAA-CREF Fixed Account.
- Moderate - we view our moderate fund as one which should provide exposure to the overall fixed income market, with returns in line with that market. In typical markets, we would expect the moderate category to provide a bit of a counterbalance to stock performance and this category would have the highest weight among the fixed income funds. The primary fund we now use for this category is PIMCO Total Return Bond Fund.
- Aggressive - we view bond funds in the aggressive category as often more similar to equities than they are to conservative bond funds. Like several of the stock funds we use, they may have a go-anywhere mandate to seek out bargains wherever they find them, or they may focus on a specific segment which has entailed a higher degree of risk. In either instance, we look to these funds for long-term return. Funds we currently use in this category are Yieldquest Total Return, Loomis Sayles Bond Fund and Yieldquest Tax Exempt.
Although equities have been performed poorly in this downturn, relative to their performance in prior downturns, many fixed income sectors have been even more strongly impacted. Some of the performance is certainly due to deteriorating economic conditions or company-specific problems with some bond issuers. However, in many instances the drop in pricing seems overdone, bearing little relation to either economic or company-specific issues. In other words, we see bargains in these sectors that will begin to be realized as markets stabilize, and we will look to invest opportunistically in these sectors in the coming months.
Equities
We invest in equities for long-term return, but clearly over the short term, equities can decrease sharply in value. To mitigate this decrease, we’ve increased cash positions in portfolios by selling index fund positions, and we’ve also moved from index funds to actively managed funds and most recently a long short fund.
As we’ve outlined before, index funds are simply designed to track the market, but given performance of late, we wanted to minimize simply tracking the market. The actively managed funds have declined as well, but most that we use have outperformed their relevant index over the past year. Secondly, we’re hopeful that these active managers will find bargains in the current environment that will power returns for years to come.
The last move we made in many portfolios recently was to reduce index fund exposure still further and use the proceeds to purchase a long-short fund. A long-short fund is designed to benefit when the market rallies, but to limit losses during a downturn. Strategies to do this are necessarily complex, and after a good deal of research, we identified a fund which met our criteria with regards to cost, transparency, performance track record and risk profile.
So, in essence, most portfolios now consist of a much smaller allocation to index funds, a large proportion of actively managed funds that will ideally find values in this particular market, and a long-short fund that will participate in an upturn, but limit downside should the market continue to trend downward.
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Financial Planning Tips - Utilities and Public Service Commissions
Micah Porter, CFA
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If you ever watched Laugh In in the early 70’s, you may remember the character Ernestine, a fictional phone operator played by Lily Tomlin. She’d sit there at her switchboard doing pretty much as she pleased, and if a caller ever complained, she’d snort and reply “We don’t care, we don’t have to...we’re the phone company.” The message here was clear, although exaggerated for humor - if you needed phone service, Ma Bell was the only game in town and you played by their rules.
While the situation has changed somewhat since then, in most instances there are few options for phone service aside from AT&T. The same is true for other utilities, particularly for electric and gas service. The companies that provide these services are typically behemoths with strict procedures, multiple departments and customer service reps that are literally spread across the globe. If you run into a problem with them, threatening to take your business elsewhere is often a hollow threat and even when it isn’t, all too often it fails to result in the level of concern you, the customer, might wish for. So what do you do?
Quite often, the best answer is to turn to the state government as many utilities are regulated by a state commission. In Georgia, the Georgia Public Service Commission regulates many companies offering local phone, electric and gas service. In many instances, these companies are, or were, granted monopolies to serve a certain area by the state, and in exchange for these monopolies, the state retained veto approval over many aspects of these companies’ business decisions. Thus, for example, when regulated utilities want to raise rates, they must first obtain approval from the Public Service Commission (PSC). Thus, it pays for the utilities to stay on the good side of the PSC, and too many customer complaints to the PSC are something a utility wants to avoid.
So how do you contact the PSC, and when should you involve them? Contacting the PSC in Georgia is straightforward, and a link to their website is here. For non-Georgia residents, visit your state’s Secretary of State website, and look for information on consumer affairs. As to when to get the PSC involved, if you feel you’re not being dealt with fairly by the utility and you’ve worked with them to resolve the issue but are getting nowhere, give the PSC a call. They’ve helped me with everything from resolving incorrect billing from the phone company to getting gas turned on quickly in the dead of a Chicago winter. They’re there to help you, the consumer, and you shouldn’t hesitate to call on them if you’re working with a regulated utility but getting nowhere.
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Client Question of the Month
Micah Porter, CFA
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If the market is fairly valued, why does it continue to decline?
Just as investors can drive stocks above fair value in a bull market, the converse can occur during a bear market. There is no real magic to fair value on a short-term basis, but the important thing to realize is that, over the longer-term from the point of fair value, stocks should return 10 to 11% annually. What has happened in the past when stocks drop well below fair value? Here’s what John Hussman, manager of Hussman Strategic Growth and one of the smarter value investors out there has to say on the subject in his most recent weekly column:
Likewise, weakness in an undervalued market tends to be temporary and impermanent. This distinction is essential. The main damage that investors can do to their financial security at this point would come from selling into steep but impermanent declines. Even in ongoing bear markets, once valuations become favorable, declines through prior levels of support are typically followed by advances back to that support. Remember that if and when things look frightening.
In other words, if stocks decline well below fair value in a bear market, in the past they’ve ultimately moved back upwards towards fair value even in the midst of the bear market. |
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