Fiduciary Wealth Partners

SJM is now Fiduciary Wealth Partners!

Please visit us at www.FWP.Partners and sign up for our new blog at www.FWP.Partners/Articles.

As many people know, SJM was named after my family, “S” for my wife Susan, “J” for my son Jack and “M” for my daughter Meghan.

When starting the firm, I told Susan that I wanted to build something special that could flourish by striving always to do the right thing for others (be a true fiduciary).  She said the family was behind me and so SJM Fiduciary Advisors (SJM) was born.

After building SJM to advise over $1 billion for a select group of clients, I was at a crossroads.  We had built a successful business but I did not have a succession plan or a partner to help make sure the business was sustainable over the long term for the benefit of my partners (clients and fellow professionals).

While thinking about what was next, over the Summer of 2014, I had dinner with a long-time friend and financial services colleague, James “Jamie” Cornell.  Over the course of the evening, we realized that we shared the vision of building a partnership that would put the interests of others first.

“Preston and I have known each other for over 10 years and have both been successful at senior levels of various financial services firms.  We have seen what works, and unfortunately what does not.  Both of us want to build a firm our families can be proud of that forms lasting partnerships with our clients, fellow professionals and our community.”

James K. Cornell, Founder and Managing Partner, Fiduciary Wealth Partners

After a few more dinners, lunches and planning meetings, Jamie and I decided to transform SJM Fiduciary Advisors into a new joint partnership, Fiduciary Wealth Partners (FWP).

We wanted the name of the firm to make a statement about the importance of building true fiduciary relationships with clients.

“We specifically picked the word ‘fiduciary’ to lead the name of the business to make a statement about the standard of care we find most important.

“By acting as what we call ‘true fiduciaries’, we focus on the interests of our clients first and do not make choices that could put us in positions of conflict with our clients.”

Preston D. McSwain, Founder and Managing Partner, Fiduciary Wealth Partners

We understand that, in managing clients’ wealth, we are being entrusted with money that is for the benefit of their family members and other important beneficiaries.  This is why we use the word “partners” in our name.  We view our clients as partners and are constantly asking ourselves the following questions:

“Are we putting the interests of our partners first?”

“Is this advice that we would give to our own families?”

Finally, and importantly, our values form our foundation.  We believe what really matters is how we treat people and the Transparency, Simplicity and Peace of Mind (TM) we bring to our partners.  To make this point, we trademarked the phrase.

To learn more about FWP, please visit us by clicking on the following contact and information links listed below:

Fiduciary Wealth Partners

Preston D. McSwain
Managing Partner and Founder

James K. Cornell
Managing Partner and Founder




Chair Yellen – Very Impressive

At lunchtime yesterday, I was fortunate to hear Chair Janet Yellen speak at the Economic Club of New York.

Much is in the paper about her talk and I have seen quite a few posts on the internet.  I am not a Federal Reserve (Fed) commentator by any standard, but I did want to at least share a few thoughts.

In the past, I have heard other top financial leaders speak at forums such as the Economic Club of New York (Bernanke, Paulson, Lagarde, etc.).  Often, speeches are very formal and the answers to questions are bland.  This was not the case yesterday.

Chair Yellen was direct and clear.  The Chair said that the Federal Reserve feels that they might reach their employment and interest rate targets in two years, and if so they will be ready with the tools necessary to take appropriate action.  Then, in a moment that got a laugh from a pretty serious audience, the Chair said, “Of course, if the economy obediently followed our forecasts, the job of central bankers would be a lot easier and their speeches would be a lot shorter.”

I have seen some pieces on the web suggesting that the Chair was a little more hawkish than anticipated.  I think the Chair was balanced.  She said the Fed feels that much still needs to be monitored in terms of evaluating factors that might push the recovery off track, and that the Fed remains concerned about slack in the labor market and low inflation.

To me, the most impressive moments of the presentation came during the question and answer session.

Questions came from Abby Cohen, the Senior U.S. strategist at Goldman Sachs, and Martin Feldstein, the George F. Baker Professor of Economics at Harvard University and president emeritus of the National Bureau of Economic Research.

Cohen started the questions and addressed Yellen twice as Madam Chair.  The Chair was open in her answers and did not shy away from making comments to Cohen that some might consider a little political.  She talked of her concerns about inequality in the labor force and the need for more education and training to close skill and income gaps.

Feldstein’s approach was quite different.  I do not remember him addressing Yellen as Chair at all and, in a baseball metaphor, others at my table joked that he seemed to test her by immediately throwing a high fast one inside.  Feldstein asked her a very pointed question that showed his concern about the potential for rising inflation and worry that the Fed was not prepared to take strong action.  She did not step away from the plate at all. The Chair paused, put on her glasses for the first and only time during the lunch, and very directly let Feldstein know that the Fed would be diligent in monitoring employment and inflation, had the tools to take action, and would take steps in a decisive manner when needed.  Yellen then firmly stated that the Fed currently feels that the “risk of not hitting our inflation target is greater than the risk of exceeding it.”  She then took off her glasses and received a spontaneous, and in my experience rare, mid-presentation round of applause.

The economy is not out of the woods yet as it relates to what the Chair stated could be structural employment issues.  I also worry that inflation is too low, and I hope that the economy hits the 2% Fed inflation target sooner vs. later.

I certainly do not have a crystal ball on what will come next in the market, but I think the Chair made it clear that the Fed will continue to be relatively accommodative for some time to come.  The market seems to parse every word from a Fed official carefully though, and some might interpret them differently.

Even though valuations could be relatively high among equities, I think risk assets will continue to benefit from low rates for some time to come, and that true long-term investors will be rewarded for sticking to long-term equity targets and investment plans (please notice that I said long-term twice – I feel too many react to every Fed comment like short-term speculators).

Again, I am not trying to be a Fed tea leaf reader and do not plan to be in the future.

More than any forecast about rates or markets, I hope others are impressed with and have confidence in the Chair.  I certainly do.


Are We Spending Too Much Time Selling Alpha?

A recent article in the NY Times titled “The Oracle of Omaha, Lately Looking a Bit Ordinary”, has prompted me to finally write a new blog.

The NY Times piece, by Jeff Sommer, highlights research by Salil Mehta, on his blog Statistical Ideas, about the virtues of index investing.  It is yet another piece that discusses how hard it seems to be to find managers that can consistently outperform index funds.

At SJM Fiduciary, we use active managers for some asset classes such as emerging market equities and ESG / SRI mandates, and, prior to starting my own firm, I spent the better part of 25 years successfully selling active management (was a Managing Director at firms that largely promoted active strategies).

In addition, I previously posted my thoughts on how investors might find a manager who adds alpha using Active Share screens titled, “A Way to Outperform Over Time?”.

Across the vast majority of equity asset classes, however, I actively encourage and implement investment plans with index funds.

Beyond consistently outperforming many active funds (some research suggests the majority), having low fees, being very transparent (easy for clients to understand what they are investing in and how they are doing), completely liquid and tax efficient, I think implementing index strategies adds value in other ways.

I have come to feel that the wealth and investing business spends too much time and money promising and selling the ability to pick a manager or strategy that can outperform an index.  Considering how hard it is to deliver on these promises, and how many resources (firm time and client fees) are spent in pursuit of something that a good amount of research indicates is very elusive, I feel we should be focusing more on other things.

Versus trying so hard to find and sell alpha, maybe we in the industry should be spending more time trying to understanding clients’ feelings about risk and reward (not presenting output from questionnaires or Monte Carlo simulations), giving full transparency (openly discussing both sides of a trade, fully disclosing all terms, potential biases and conflicts, etc.), and, importantly, making investors comfortable with their investments, so they have a greater likelihood of sticking to their plans.

Investing should not be a competition, it should be a tool that allows a person or an entity to reach specific goals (a means to an end).

If more advisors used index funds, it might reduce what, based on many research pieces similar to what is mentioned in the NY Times article, could be relatively unproductive competitions to find and sell alpha.

In addition, I feel that it would allow us to devote more time and resources to improving client experiences and forming stronger relationships.

I am finding that more and more clients desire simplicity.  Even Warren Buffet seems to have feelings that tilt this way.  The NY Times article I mentioned above reports that Buffet has given instructions for a family trust to, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”

Humans are inherently competitive, and index funds are not for everyone (some want to strive to find the New New thing), but I feel that the aggressive pursuit of alpha at the potential expense of greater simplicity, transparency and, in many cases, better performance, should be discussed more directly with clients.

More than selling alpha, relative performance and relative risk metrics (Sharpe ratio comparisons, etc.), let’s spend more time openly discussing both sides of topics, such as the active vs. passive debate, listening to clients and implementing strategies that increase comfort.

If we spent more time offering transparency and peace of mind, I think it would increase trust in our industry as a whole and help us form more lasting client partnerships.

Economic Consensus Points to Slower Growth – Is This a Signal to Buy?

For those who have read my past blogs, you know by now that I like to explore the road less traveled and have a contrarian streak.  My kids also know this.  I often tell them, “don’t be a sheep.”  When I hear people talk about market outcomes as if they are self-evident, I feel the opposite is about to happen and that the herd should often not be followed.

Driving in on Monday morning, I heard on the radio that a new survey had come out from business economists. According to the report, the overwhelming findings of many top economists point to a tough road ahead for the U.S. economy.

It is true that the global economy has seen better days and that some things might get worse before they get better. Based upon the prognostications of chief economists and market strategists, it seems like many large investment firms are getting more cautious on risk assets.  Some are suggesting that clients pull back from equities.  I saw an e-mail titled “the coming crash” at the end of last week, and fund flows show that investors are still heavily favoring bonds over equities.

I have some worries about risk assets.  I get more worried, however, when I start to see everyone heading one way, especially when the way might be toward bonds or alternative investments that can have high fees.  Unlike the fun that I had with the title of this blog, I am not suggesting that clients go out and load up on risk assets such as equities.  Keep in mind, though, that a good reason exists for calling equities risk assets.  Risk assets are risky.  In exchange for risk, however, they often offer good long-term returns.  This is especially true when you buy them when other people are concerned, and then have the fortitude to hold them as a long-term investor (notice that I used long-term to end the past two sentences).

To highlight the thoughts of people who think that risk assets are currently a good risk / reward opportunity, below I have added a link to recent piece put out by Richard Bernstein.  In addition, I like the following quote, which were the first words he spoke during a speech he made at a conference in Boston last Friday:

“To start, I want everyone to know that I am very bullish.  This will be the biggest bull market of my career.”

Richard Bernstein Advisors – This is What Bull Markets Are All About

He is taking the other side, again, which I value.  Keep in mind that this is a guy who had the guts to question the bull market in housing and turn bearish when he was the Global Chief Investment Officer of a major Wall Street firm.  I say guts because it is hard to run against the herd.

“It is the long term investor who will in practice come in for the most criticism.  For it is in the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion.  If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy.”  – John Maynard Keynes

As to my personal thoughts about the power of prognostications of many senior economists, one of my favorite quotes is from the founder of my old firm, Roy Neuberger.  People would often ask Roy why he did not employ any economists at Neuberger Berman.  He would gruffly reply, “If I hired one I would probably have to pay them and then I might be inclined to listen to them.”

I should say that it is a tribute to Roy’s legacy that Neuberger Berman continues to do well.  They deserve the nice Barron’s lead article of a week ago.  FYI, like Rich Bernstein, many of the top managers at Neuberger are positive on equities.

Barron’s – Neuberger Berman Fair Winds Ahead

So, what do I suggest?  Get ready.  Yes, I am a broken record on this.  Be a long-term investor.  Decide on a prudent long-term investment plan (long-term is at least 5 -10 years) that is designed to meet your goals (not the goals of others).  Don’t take big bets, ever.  Keep it simple (only invest in what you understand and hence feel comfortable staying in for the long-term).  And, when strong consensus builds, consider moving the other way.  Just do so within reasonable limits (no big bets / prudently contrarian).  This way, if the herd is correct (rare occurrence) you will sleep better.  If you are a glutton for my thoughts, you can reference my past 10 Rules / Thoughts to Consider blog.

SJM 10 Rules / Thoughts to Consider

A little equity pull back at this time is fine if it makes you feel more comfortable.  It is your plan and your money.  Just be mindful of the options for where to put it.  You have two main choices, with a possible option for a third.

#1 Cash –  Money market / cash instrument funds offer zero return on capital but they do offer return of capital.

#2 Bonds – They currently offer very little return on capital with high interest rate risk.  Lower levels of high yield and instruments such as leveraged bank loans offer some opportunities, but be sure you are diversified, understand them and feel comfortable.  They are likely to be a little volatile.

Optional #3 –  Alternatives / Hedge Funds – Some very talented, non-directional investors exist.  The “return of capital” line is a favorite of a very successful one here in Boston.  Just keep in mind that fees are high (better be good), transparency is low (better do your due diligence and have a high degree of trust) and liquidity can be low (better be mindful that your money will not be easily or readily accessible).

Personally, I would not be quick to pull back from equities unless I had gone outside the range that I set for equities as a part of my long-term plan.   If I did rebalance, I would move into very short-term, cash-like bonds (money market funds) and expect nothing more than a return of capital.

Taking little to no action is not easy.  Second guessing yourself can happen (“If I had only…”), especially when you look wrong on any one day, week, month or quarter.  We all have action bias and feel better moving, even when we are wrong (remember that Nobel prize for behavioral finance).

As long as I am following my investment plan, I feel more comfortable resisting the urge to make a move.  I try to resist even more when the consensus starts to look like a herd of fluffy sheep.  Nice fluffy sheep often get sheared.

Happy End of Summer – 10 Rules / Thoughts to Consider

I hope this finds everyone having had a great Summer.   All has been well at SJM.  I have been taking the opportunity over the past few months to visit with clients and key members of the community, grow the business and increase resources and, yes, take some time off to reflect and recharge for the Fall.

The Summer brought many interesting headlines and events.  Europe still dominated the investment headlines and more talk surfaced about growth, or maybe I should say lack of growth, in China.  As I have mentioned to many clients, don’t expect any of this talk to go away soon.  No fix to Europe exists without more pain, and export-driven economies such as China cannot grow if the world’s largest trading block (Europe) is in recession.

Mr. Market has brushed off slow growth news, however, and has had a good run.  The S&P500 is up approximately 10% since May.

I am happy with this increase in asset values but, based on concerns about growth, I remain cautious.  Stocks seem to have moved higher based on the hope that governments around the globe will continue to pump money into the system with low rates or bond purchases.  I would prefer to see the market going higher based on solid top line revenue growth and strong bottom line profit growth but, as is often said, don’t fight the Fed.

At the end of last week, Bernanke gave his annual Jackson Hole speech.  As anticipated, he suggested that the Fed will keep rates quite low for the foreseeable future.  He also left the door wide open for more easing.  If the Open Market Committee announces some form of QE3 in September, stocks are likely to continue up for the rest of the year.

Outside the U.S., if markets sense that more consensus exists among European policymakers toward market support (again, true stability and long-term resolution of issues in Europe are very unlikely), risk assets such as stocks should also get a short-term boost.

What does all of this portend for the Fall?

It is a very uncertain time.  Day to day, markets seem to be reacting more to comments from policymakers than to economic fundamentals.  As I have experienced on the water this Summer, winds, particularly winds driven by politics, can change quickly.

Bulls and Bears both continue to have solid arguments, and I could easily take either side of the debate.  The most recent issue of Barron’s has a good summary of thoughts from many well-respected market strategists titled Tough as Teflon” (you might need a Barron’s subscription but hopefully this link will allow you one view for free).  As the piece points out, despite some rough news, the market keeps bouncing back and remains tough.  Strategists such as Tom Lee from JPM are considered to be bullish, Bob Doll at Blackrock is cautiously optimistic, and individuals such as Barry Knapp at Barclays have in the past been concerned about a pullback.  Beyond the hotlinks above, we will post updated links to the latest thoughts from many industry leaders on our Idea Flow page later this week.

So, what should investors do?

The market could remain tough and move higher or, as happens after too much use, the teflon coating might start to come off.

As is always wise on the water, be respectful that conditions can change rapidly.  Be prepared and stay broadly diversified.  Don’t reach for returns.  Keep focused on your long-term plan and don’t be sold the hot investment strategy.  Staying with the boating theme, and an old tried and true saying, make sure your “ventures are not in one bottom trusted” (Merchant of Venice – Shakespeare).

To offer some ideas that I hope you will find useful, below I have listed 10 rules of investing for successful long-term market navigation.  They are certainly not “the” rules but are ideas that I have found useful.

Enjoy the start to the Fall!


10 Rules To Consider

1.    Investing is Not a Competition – Invest for Your Goals

2.    View Risk in Terms of Evaluating the Permanent Loss of Capital – Risk is Not the Variation of Returns / Standard Deviation

3.    Do Not Run with the Herd – Be Contrarian

4.    Understand the Position of the Person or Firm Producing the Research and Remember that Many Investment Theories are, well, Theories

5.    Be Patient – Good Ideas of True Long Term Investors Often Are Rewarded

6.    Avoid Leverage – It Can Offer More Upside but the Risk / Reward Often is Not Worth It Over the Long Term

7.    Understand and Value Liquidity – It Should Always Be Placed at a Premium

8.    Be Curious and Understand All Sides of A Trade / Argument

9.    Only Invest in What You Understand – Do Not Be Sold

10.  History Tends to Repeat Itself or At Least Rhyme (Thank You Mr. Twain) – Try to Learn from the Past Mistakes of Others – The Investment World Certainly Offers us Many Mistakes to Learn From




The Dollar Bet That I Unfortunately Won – Blog Update From Last Week with Good Articles

The first part of this Blog goes out to Mike.  I am indeed very sorry that I won that dollar bet.  I would much rather have lost it.

To bring you all in on this, at the beginning of last week, I bet a friend and well respected portfolio manager a dollar that the U.S. 10 year treasury bond would go below 1.5%.  He took the other side.  The bet had some seriousness behind it, but I didn’t think I would win any time soon and he was encouraged by his chances of getting a buck off me.  I even told Mike that I was going to hedge my big bet by selling some of my intermediate term bonds.  I sold some bonds, and unfortunately on Friday I also won a dollar.  The U.S. 10 year ended the week at 1.46% (first time ever below 1.5%).

I say unfortunately because of what signifies about how investors are viewing the strength of the global economy (rates on 2 year German bonds went below zero).  You also saw this through the equity market drop by more than 2% on Friday.

The stock market always seems to make larger headlines, but equity investors can be short-term in nature.  The day-to-day moves of the stock market often do not tell us much about what the future may bring.  Bond investors tend to have longer-term time horizons, however, and movements in interest rates can sometimes give an indication of what lies ahead.  Investors demanding only 1.5% on a 10 year loan to the U.S. government tells you what they think about the risk / return opportunities going forward in other areas.

Last weekend I posted a Blog that, due to some technical difficulties with a network solutions server, did not got out to everyone.  Who knows, maybe it was the length of it.  I did get a little wordy.  If you have a moment, please consider taking at least a scan at the link below.  It will hopefully give you a useful indication of our thoughts.

At the end of this Blog, I have also re-posted links to recent commentary that I feel is worth a read and added a good piece from Bill Gross.

A Few Interesting Articles – Planning for What We Can Control

As an update on my thoughts from last week, I am still suggesting that investors not make any big changes to asset allocations beyond what we have been encouraging our clients to do throughout the year.  In summary, the following are our long-term and current recommendations:

Have A Long-Term Plan and That Is Designed to Meet Your Individual Goals
–  Investing should not be a competition
–  Unless your goals have changed, do not throw out a good plan with a bad market

Set Investment Policy Max. and Min. Ranges For Various Types of Investments
–  Everyone will be wrong from time to time
–  Set limits on the upside and downside before you invest
–  Max. and Min. ranges should help to control emotions and hence risk

Try to Think Outside the Box and Consider Being Contrarian
–  Wall Street’s herd can be wrong ( see Are Wall Street Earning Estimates Good Barometers )
–  Large flows into and out of an asset class are often a sign of a top or bottom

Always Place a Premium on Liquidity
–  Don’t invest in illiquid investments unless the rewards being offered are compelling
–  Why do investors tend to pay higher fees for lower liquidity?
–  Carefully evaluate return and risk opportunities being offered when taking on illiqudity

Use History As a Guide But Don’t Get Anchored on Past Returns or Risks
–  Are traditionally low risk bonds going to be much higher in risk going forward?
–  With rates at 1.5% on the 10 year bond, risks going forward could be high

Understand True Risk Exposures of All Investments
–  Do high yield and emerging market bonds and distressed debt have the same risk as other bonds?

Currently Consider Reducing Interest Rate Risk and GDP Risk
–  Don’t double down on the 10 year bond going much lower
–  Even though we were early on reducing a few bonds at 2% levels, we are selling more
–  Commodities and Emerging Market Stocks can be linked to GDP growth expectations
–  We started recommending reductions in Commodities and EM equities early this year
–  World GDP could continue to slow
–  It is not too late to reduce Commodities and EM equities

Unlike last weekend, I have not been looking out the window at glorious sunny days this weekend.  Rain has moved in, which might have us all in the Northeastern part of the U.S. thinking gloomy thoughts.  All storms eventually clear though and certain areas of the market will continue to provide solid long-term investment opportunities.  A true long-term investor ( who will in practice come in for the most criticism ) will continue to be rewarded for keeping a steady hand on the tiller.

Now, I am off to enjoy weekend time with SJM (Susan, Jack and Meghan).

I hope everyone had a nice weekend.  Please do consider a read of the articles below.


GMO – Flaws of Finance – “Why We Need a Hippocratic Oath in Finance”
James Montier again has put out a great piece that will probably not be popular with some of his investment peers.  It is long but worth a scan of at least the first and last sections.


Richard Bernstein – Diversification Remains Difficult
Richard Bernstein – An Alternative to Alternatives
Like Montier at GMO, Rich is not afraid to take the path less traveled and question the industry.  In these pieces, he lays out the importance of a well diversified long-term plan and then suggests, as I also believe, that we need a back to the future look at alternative investments (hedge funds, etc.).  He nicely points out that many (not all) alternatives investments can be bettered by good old fashioned asset allocation among stocks, bonds and cash.  The old fashioned way, however, has the advantage of high liquidity, high transparency and low fees.


WSJ – How to Play the Bond Market Now
I have been meaning to post this for quite some time.  It gives a good overview of the current risks in the bond market.  Going forward, bonds might not be as low risk as they have in the past.


Bill Gross – Wall Street Food Chain
Gross is again out with a good thought provoking piece.  The week, a good client and friend suggested that I read Chapter 23 of Moby Dick.  His piece in general, and the following quote, makes me think Gross might be dusting off a copy himself:  “Bond, equity and all financial assets, which are structurally bound together by this dynamic ( leverage ), must lower return expectations.  Maintain a vigilant watch matey!”



A Few New Interesting Articles – Planning For What We Can Control

First, for those who wish to go straight to the New Interesting Articles they are at the bottom of this post. This is to help you find them but also to hopefully get you to scroll through my musings along the way.

As I write this, those of us in the Northeastern part of the U.S. have enjoyed what has been a glorious holiday weekend outside.  For those in other areas, I hope you have also had a nice time with family and/or friends.

Unfortunately, the past few weeks have not been such a pretty place for the equity markets.  The S&P 500 has been steadily moving down and is now only up approximately 4.8% for the year.  Keep in mind that this is a pull back from the 3-31 YTD number of over 12.5% and puts the trailing 1 year return of the S&P back in the negative at -1.0%.

The U.S. treasury bond market on the other has had a very strong rally, which is not necessarily a good thing.  The 10 year treasury is now back close to record lows.  This means that people might be having doubts about our recommendation to lighten up on bonds at the end of Q1 when rates were at approximately 2%.  We admit that we were wrong in the short-term but with rates this low we are inclined to lighten up yet again.

The problem is that if one were to reduce an asset class at this time, where do you put the money.

U.S. treasury rates should go higher, but as long as Greece and the worry about its problems spreading to Spain continue, U.S. rates could stay very low for some time. When rates turn though, and they certainly will at some point, the impact will be large.  I wrote about this in a Blog titled “This Week’s Big Question”.  As an update, I have put a link below to a WSJ piece that I encourage you to read.  Unfortunately, the WSJ does not paint an easy road or pretty picture.

Equities have pulled back approximately 10%.  Normally this type of decline can be a good buying opportunity.  With large parts of world either slowing (Europe and China) or only experiencing slow / modest growth (U.S.), however, demand for products and services could also slow, which in turn could affect profit margins.  Companies can only improve productivity so much, and a few signs lately have suggested that productivity gains might be tapering off.  At the end of the day companies need to grow top line (revenue / sales) from end demand for products and services.  This said, if the Greek tragedy takes even a little turn for the better, equity markets could have a nice relief rally.

Versus making any large calls, for now I am sticking to my standard lines.  I feel all should be long-term investors, remain broadly diversified, be somewhat contrarian, not follow the herd and make sure that a portfolios are invested to meet an individual’s or institution’s goals, not the models or goals of others.

On the investment side, we feel that investors might be well served to take this time to look outside the box and become more comfortable with what historically might have been thought of as smaller parts of the asset allocation pie.  Assets that come to mind are higher quality high yield bonds, convertible bonds, high dividend equities (these once were market favorites but fell out of favor in the late 80s and 90s), and what we call hybrid high income equities (MLPs, REITs, etc.).  I am starting to question why some of these securities have historically had such a small allocation slice.  When you look at the long-term risk and return charteristics of some of these securities or asset classes, they can be quite attractive.  I touched on this a few weeks ago in my Blog titled “Does Lower Risk = Higher Returns in the Equity Market”.

Next, be ready for new products.  Wall Street will almost certainly start creating new types of investment opportunities based on what could be a new normal.  The Street is very good at filling demand for new ideas.  Some of them will be prove to be worthy over the long run (think MLPs from the early 90s) but many will have to be carefully watched for flaws (auction rate securities, etc.).  Being the first to buy a new product often does not turn out that well in the investment world.  Please only invest in things that meet your plan and that you understand well.

As for your plan, if you have not laid out a true investment and wealth strategy, this is a wonderful time to get anchored on a good road map for achieving your goals.  This plan should include an Investment Policy Statement or Framework that sets long-term targets for various asset classes and maximum and minimum risk control ranges around the targets.  This way, regardless of the emotion of the market, you can keep yourself from making big bets that can turn into big mistakes.  An example would be having a long-term target of 40% in bonds with a range minimum of 25%.  With rates so low, you to go closer to you minimum but not below it.  This would keep you from going so low that you are not in bonds when rates go from the “should not go much lower” than 2% level down to 1.7% (yes, just happened).

This approach will also allow you to stay invested in equities when thing look the worst.  A long-term target of 60% in equities with a low end range of 45% would have caused you to move up in equities in March 2009 to avoid going below your minimum.  Very few people did this as the S&P 500 hit the “world is going to end” level of 666 during this time period.  The old you should “invest when blood is in the street” saying often holds true. As of last Friday’s close, the S&P 500 is now at 1,317.

In addition, we recommend that all take time to understand real risk exposures and true liquidity profiles.

Above I mentioned high yield bonds.  I think they have attractive return and risk characteristics over most time periods (they have outperformed equities and government and investment grade bonds over the past 3 and 5 year periods), but they are not regular bonds.  As an example, if you move out of investment grade bonds such as U.S. treasuries and into high yield bonds it is a bond for bond swap.  It is not, however, a like risk for risk swap.  You are going from something that historically has very low volatility (if rates move higher faster it will not feel this way) into something that has what we call moderate risk / volatility.   If you are not prepared for this, a swing the wrong way might cause you to get out of an investment such as high yield bonds at the wrong time.  Because of this we have started talking to clients in terms of high, moderate and low risk, versus just the traditional stock, bond and cash classifications.

We are also focused on understanding a client’s true liquidity position. Many large endowments went through this painful exercise recently.  Investments can sound and indeed be good but global markets change, and it is always nice to be able to change within a range when appropriate (remember the comments above about ranges).  A potentially more important reason to put a premium on liquidity is that the manager or the management of an investment strategy can change.  We often say that a strategies do not blow up, managers do.  If you are locked up in an asset class or investment vehicle for a month, quarter, year or in some cases multiple years, with notice periods that can be 30-90 days prior to the start of a redemption period, you can find yourself trapped in an investment at the wrong time.  Remember, a fund that states quarterly liquidity with 90 days prior notice is really giving you only semi-annual liquidity (quarterly + 90 days notice = 6 months of advanced planning before you have access to funds).

Illiquidity can also cause you to get outside your ranges because of distribution needs.  If you have a big outflow need (medical, distribution requirement from a trust or charitable entity, etc.), and you have low liquidity in certain areas of your portfolio, it might require you to take funds from an asset that is attractive because you can not get funds from any other area.  An example might be that you have a solid bond portfolio that is generating attractive income and offering some downside protection and diversification as compared to other investments.  You need to take a distribution from your portfolio but other areas are illiquid.  This puts you into a position of having to sell your bonds and hold the illiquid investments that might not be well positioned for the future.  Next thing you know, all the good planning you put in place to have a low end range of 25% in bonds goes out the window.  You have to move significantly lower than 25% at what might be the wrong time because you cannot get funds from any other area.

To help with this, we are starting to lay out investment frameworks for clients with maximum and minimum ranges for high, moderate and low liquidity investments.   When combined with the more simplistic high, moderate and low risk metrics, we feel it gives us another way to help clients think through a plan.  This is not the only way; just another way that might be a little outside the box and hopefully helpful.  Over the next few weeks we will post an example of some of this work and will welcome comments.

Finally, at this time of uncertainty, I would encourage individuals to take time to do planning around things that are certain.  Taxes and death.   I know these are uncomfortable topics, but planning in these areas is an important part of an integrated wealth plan.  Versus trying to take this to a detailed discussion of various complex tax and trust and estate planning techniques, which might be dangerous for all, I encourage everyone to look at some current opportunities.  As an example, taxes on capital gains are likely to go up.  Take this time to review legacy positions and managers that might have large unrealized gains.  If they are still appropriate then hold, but if you can optimize your portfolio to increase quality, diversification, liquidity and/or lower fees, don’t let taxes drive the decision.

I am also encouraging clients to speak with tax and trust advisors to discuss making taxable gifts now.  Again, I am not a tax or trust professional, but it is generally less expensive to give money away while you are living and rates could move higher soon.  Other wealth transfer strategies such as GRATs (grantor retained annuity trusts) are also very attractive now due to low interest rates.

In summary, I am not sure that large allocation moves are appproprite at this time.  However, I do feel that it is a great time to get a better understanding of how your plan is structured.

Do you have a good understanding of all of your true risk and liquidity positions?

Do you have an investment plan that is being optimized based on the current, and likely future, state of income and estate tax laws?

Try to get or stay anchored on your plan and things you can control versus what is happening with Facebook, Greece or Spain.  By doing this, hopefully we can all enjoy weekends more.

Now, if you have made it this far, and wish to read more from commentators that are more well known, please consider clicking on the links below to a few recent pieces that I think are worth a few more minutes.

GMO – Flaws of Finance – “Why We Need a Hippocratic Oath in Finance”

James Montier again has put out a great piece that will probably not be popular with some of his investment peers.  It is long but worth a scan of at least the first and last sections.

Richard Bernstein – Diversification Remains Difficult


Richard Bernstein – An Alternative to Alternatives

Like Montier at GMO, Rich is not afraid to take the path less traveled and question the industry.  In these pieces, he lays out the importance of a well diversified long-term plan and then suggests, as I also believe, that we need a back to the future look at alternative investments (hedge funds, etc.).  He nicely points out that many (not all) alternatives investments can be bettered by good old fashion asset allocation among stocks, bonds and cash.  The old fashioned way, however, has the advantage of high liquidity, high transparency and low fees.

WSJ – How to Play the Bond Market Now

I have been meaning to post this for quite some time.  It gives a good overview of the current risks in the bond market.  Going forward, the risk of bonds (both volatility and the potential for loss of value) might increase.

Does Lower Risk = Higher Long-Term Equity Returns?

With both bulls and bears now having valid points about what the future may bring, I decided to title this Blog to spark a little debate about how the industry discusses risk and return in the equity market.

As I say on the website, SJM feels that healthy banter about what are sometimes provocative ideas leads to better decisions.  In the investment world, this can be even more important as a trade always has two sides (willing buyer and seller).  At the end of the day, we all need to be careful to not get trapped in a debate loop and non-action.  You have to move forward and take actions that you feel are appropriate, but why not take a little time to look around and sometimes explore the road less traveled.

Before I go much further, I want to give full credit to a white paper that PIMCO published back in January 2012.  Re-reading their piece this past week is what drove me toward what might be a heretical title question (yes, this is a question) to those who are close followers of the Capital Asset Pricing Model (CAPM) theory and Effecient Market Hypothesis (EMH) (yes, also notice the words theory and hypothesis).

Please consider taking time to read the full report at the below link.

PIMCO Insights – Stock Volatility: Not What You Might Think

In the hope that you will still click on the above link to get the full story, in short I feel the PIMCO study supplies a new theory and the following questions that should be considered.

Over the long run, do low volatility stocks lead to higher returns because they have lower downside risk and hence allow for greater compounding by avoiding the larger negative returns that higher volatility stocks can produce? (The PIMCO research lists some compelling charts to make this case in both Developed and Emerging Markets.)

Do human behavioral traits such as overconfidence and herd mentality amplify the potential negatives of high volatility stocks because we are likely to make the wrong timing decisions and get into higher volatility stocks later in a cycle and closer to their larger downturns relative to low volatility stocks?

Do incentives in the investment industry drive some firms and professionals to take larger risks because bonuses can be higher if they hit one out of the park in any one year? (keep in mind that these comments are echoed by PIMCO who is a firm that has to deal with these issues)

As PIMCO also concludes, I feel their data suggests that lower risk may lead to higher returns for long-term equity investors.  I think this might be compounded based on my belief that smoother rides generally allow both individuals and institutions to feel more comfortable sticking to long-term plans, which then creates better opportunities to achieve individual goals.

In all of this, I am not suggesting that the higher risk higher return graphs we have all grown up with be thrown out, and I am not trying to take a bearish position.  I am also sure that others can come up with charts to debunk some of what PIMCO published.  I just think we might need to think outside the box a little more and be open to different ways of evaulating risk and return when discussing equities.

This is sure to get a few e-mails, which I welcome.

Enjoy and, importantly, try to stick to your long-term plan.

A Way to Outperform Over Time?

The S&P 500 index just ended the best 1st quarter since 1998, up 12%.  Is this a foreshadowing of more good things to come or is this too far too fast?  We shall see.  Regardless, the age old question and quest continues.  Can an investor outperform, and do attributes exist among certain investors that give them the opportunity to add value over a long period of time.

As the performance of various managers comes in over the next few weeks, many investors who strive to outperform the market (active managers) will probably have helped to make the case for those who believe that a passive index approach is a more appropriate way to invest.  It is easy to find articles about the virtues of an index versus an active management approach.  Many suggest that performance persistence is not achievable and that, especially after fees and taxes, investing with active managers to try to outperform is a losing game.

I do not dispute the statistics that make the passive index investment case.  I believe, however, that certain characteristics do give specific types of investors long-term advantages over just buying the market (index investing).

Before I go much further, please keep in mind that I just said long-term.  Quarter to quarter or even year to year is not a good time frame to make decisions about investing.  I feel that many have become overly relative performance-oriented on time frames that are too short.

Also, percent outperformance or underperformance does not necessarily tell the whole story, nor is it necessarily the appropriate question depending on what you are trying to achieve.  As an example, is an equity manager that outperforms on a return performance basis over time the best manager if that manager has such large swings month to month or quarter to quarter that it makes clients nervous and they then move out of equities altogether at maybe the wrong time?  Or is the best manager, in certain cases, the manager that does underperform the market slightly from time to time, but creates a  smoother, more comforting ride, which allows clients to stay invested through the good and bad to acheive long-term goals?  A discussion of these questions is another Blog altogether, but I wanted to at least get it out there before I talk about ways that I think some investors / managers might be able consistently to add value.

Three things made me start to write this Blog today.

First, we are finally experiencing the normal New England Spring.  Kinda gray, a little cold and maybe even some snow flurries in the forecast (not much outside play with my SJM).

Second, the market performance I mentioned above.  With the market up 12% in just one quarter, many managers probably will have underperformed.

Third, there is a good piece in the Wall Street Journal weekend edition by Jason Zweig in his Intelligent Investor column.  It talks about Maynard Keynes who, regardless of how you feel about his economic thoughts, was, according this article, an exceptional investor during a very difficult period.

Zweig bases much of his piece on a recent published study that David Chambers and Elroy Dimson from the University of Cambridge and the London School of Business did on Keynes’s investment track record when he ran the endowment fund of King’s College Cambridge from 1924-1946.  Is it true that many investors cannot outperform the market, but Keynes was not one of them.  According to the WSJ article, during an era that included the Great Depression and WW II, Keynes outperformed the market by an average of 8% annually.  Other successful investors such as our local Boston star, Peter Lynch, and the oracle of Omaha, Warren Buffett, are also mentioned by Zweig.

When I hear stories of exceptional performance in any field, I always strive to find out if it is repeatable.  In the case of investing, I think certain characteristics of successful long term investors do exist and that if more investors followed them, more would outperform over time.

Beyond the Zweig mention of Keynes and others, a study on the SJM Idea Flow page titled How Active Is Your Fund Manager? – New Measure That Predicts Performance? is a piece of solid research from Yale, which suggests that past performance might be indicative of future returns for some types of long-only stock pickers.  I am not suggesting that past performance warning disclosures are not appropriate, but the abstract and conclusion of this research suggests that they may need to be revised for some types of managers.

I recommend a read of Zweig’s WSJ article and a scan of the conclusion in the Yale research piece to get more of the full story but, in summary, they both share common themes.  Many of these ideas are also in some of the published pieces by successful investors such as Lynch and Buffet.  They all suggest that some outside the box, individual stock picking, concentrated managers consistently can add value.  It is interesting to note that in Zweig’s article, he suggests that Keynes only started to outperform significantly when he changed his investment approach to be more focused on individual stock picking versus a more macro style.

As I briefly mentioned at the start of this Blog, all of the authors above also suggest that investors should remain anchored on an important point: long-term investing.  Zweig includes one of my favorite quotes from Keynes that makes this point better than most and in a colorful way.   “It is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism.  For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion.  If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy.  Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Following this theme, I find that investors who outperform tend to be unconventional.  They do not follow the herd, are quite contrarian from time to time, and are patient to let an investment idea play out over years versus just months or quarters.

As the Zweig article suggests and the Yale study highlights, if an investor is looking to outperform an index, he or she needs to be non-index like.  This means that portfolios will be constructed one stock / security at a time based on independent fundamental research, and that the portfolios will show conviction by being prudently diversified, but concentrated by what has become conventional practice (20-30 securities).

So, if you want to strive to outperform the market, how do you find the current or next Keynes or Lynch?

Finding these managers is not easy and it requires a long evaluation timeframe.

As Zweig mentions in the WSJ, many managers focus on staying close to the herd by constructing portfolios based on marco / sector themes that fit into “style boxes” (large cap growth, small cap value, etc.), holding large numbers of securities (50-100+) that have commonality to an index, and on constructing portfolios designed to have a tight tracking error (i.e., performance that relatively closely tracks an index, monthly or quarterly).  It is hard not to see why a manager might follow this approach, which often is called a top down style.  If a manager stays close to an index every quarter and inside his or her peer group box, he or she will not be an outlier from the herd at the wrong time.  He or she might not have to experience the short-term lack of mercy shown to the zebra who finds itself outside the herd when the lions are roaming.  Unfortunately, studies such as the one from Yale suggest that these top down, style box oriented approaches have a very difficult time showing performance persistence / consistency of outperformance.

Alternatively, the Yale study, the Zweig article, and comments in books by Lynch and Buffet all seem to suggest that if you look for bottom up individual stock / security picking managers that are not afraid to be unconventional and can resist short-term criticism, you can find managers that can outperform over reasonable periods of time.

The Yale study goes on to stay that if you find bottom up managers that are still relatively small, and hence can stay under the pressure-to-conform radar screen, those who add value through individual stock / security picking seem to be able to show performance persistence in the future / consistently outperform.

Looking at this another way, in today’s WSJ, Zweig writes that “it is worth hiring an active money manger only if you have the confidence that he or she is a free spirit who will have a completely free hand.  Otherwise…  you might as well buy an index fund.”

I agree.

More important than outperfoming an index though, make sure you are working to perform according to your plan.  At SJM, we feel we can help clients indentify some bottom up stock picking firms that have the ability to outperform an index.  We feel it is much more important, however, to make sure that you feel good about your plan and results, which hopefully allow you to feel comfortable enough during the good and bad to stick to your plan.

Beyond how a manager manages a portfolio, if you do not feel comfortable getting a quarterly or even annual report that shows large deviations from an index or a peer group from time to time, then consider using index strategies to implement your plan and rebalanced your asset allocation back to your plan often.

Regardless of plan implementation with index funds or active managers, we strongly feel that too many people are too focused on short term performance relative to a benchmark / index or peer group (industry / manager category or friends at the club).

To outperform, try to find an advisor (professional firm or private fiduciary) who is transparent, is as unconflicted as possible, freely discloses and discusses conflicts, is not afraid to bring up and suggest unconventional and contrarian ideas, and helps you craft a plan that you feel comfortable sticking with.

Ok….   Back to my plan to spend time with my personal SJM (Susan, Jack and Meghan).

Enjoy the weekend and week to come!




This Week’s Big Question

Every week people ask us good questions that spark healthy debate.  Keep them coming.

The question of the week this time around was, “Is the Bull Market in Bonds Over?”.

Over the last few weeks, the 10 year U.S. Treasury Bond has gone from approximately 1.80% to 2.25%.  This is a large move in a short time.  It caused the Treasury market to experience the worst losing streak since 2006.

Why is this move to rates that are still only 2.25% a concern?  The answer is that some feel this might be the start of a larger more consistent move higher.

Before we go much further, keep in mind that a period of consistently rising interest rates is a scenario that very few active investors (professionals included) have ever experienced.  As the chart below shows, unless you started your investing career in the 1970s, you have lived in a steadily declining interest rate environment.

If we are entering a long-term period of rising rates, it will have large implications across many asset classes and the economy as a whole.  Rates for borrowing will increase.  Higher rates will impact the consumer and the cost of capital for businesses, which will in turn be a drag on profits.  We could spend quite a few Blogs on this, but for now we will focus primarily on the question at hand, the bond market.

Keep in mind that when rates go up, bond prices go down.  Most individuals that we know have intermediate bond portfolios with interest rate sensitivity factors (in the industry we use the term duration) of approximately 5% (the Barclays Agg index duration is currently 5%).  This means that for every 1% movement in bond rates, the value of a portfolio is likely to move in the opposite direction by 5%.  As an example, if rates go up 1%, the value of a bond portfolio with a 5% duration will drop on a mark to market basis by approximately 5%.

Looking back at the chart above, rates have been moving one way since the early 80s.  This means that over the past 30 years, investors have never seen a multi-year trend of negative returns in bonds.  With rates going down, bond investors have grown accustomed to seeing statements reflecting positive returns and relative stability.

If rates start to rise, they have the ability not only to change total portfolio returns but also investor behavior and attitudes toward Fixed Income.  Values of Fixed Income might no longer seem fixed and, even taking into account the income bonds produce, values might decline.  Based on 30 years of experience, this might come as a shock to many.

Before we move into Behavioral Finance and how this all might affect investors’ actions, let’s look at where we are today and try to answer the Big Question.

As background on the current bond market, despite record deficits and last year’s downgrade of the United States, the US Treasury market has benefited from a number of tailwinds: the reserve currency status of the US dollar, lingering aversion to equities (flows into equities have been moderate at best), slow growth, and a private sector deleveraging.

Even when you take all this into account, however, Treasury yields appear too low.  Last year, the yield on the 10-year Treasury fell below Core Inflation for the first time since 1980.  By almost every measure, real rates are now negative.  To put this in perspective, over the past 50 years, Treasury yields have typically been 2.5-3.0% above inflation and this is all happening when we have had record U.S. debt and a credit downgrade.

Low yields have been due to a flight to quality in the Treasuries versus other government debt (thank you Europe – I guess), and slow growth, which has kept the demand for capital relatively low.  Weak or slow growth explains why real yields should be very low but not, however, why they should be negative.

So, as an initial answer to the Big Question, in our opinion, rates on the 10 year Treasury should probably be 1-1.5% higher.

If rates were to move up by this much it certainly would feel like the end of the Bull Market in bonds.  Investors would get statements that show the value of bonds decreasing by 5-7.5%, which might cause selling in bonds and send rates even higher.

SJM is encouraging investors to be prepared for this.  It could happen relatively quickly and could be a shock (remember most have never seen values drop like this in bonds).  If it does happen, however, keep in mind that it will be because markets are feeling that the growth we have been seeing in some areas of the U.S. economy is sustainable.  This will be good news for other asset classes such as equities.

We think the real question is what happens once we get 1-1.5% higher on the 10 year Treasury.  Will it continue to move higher?

Can the U.S. continue to show solid growth when Europe is almost certainly in wide recession, and some other countries such as China seem to be slowing?  We hope so, but do not think we are going to be entering a period of high growth given this backdrop anytime soon (more on this later).

At the end of the day, the markets will decide rates.  Will private investors and public institiutions (governments, pension funds, etc.) be net sellers (prices go down and rates go up) or will they be net buyers (prices stay the same or go up and rates stay the same or even go down)?

This past week, a report came out by some well respected researchers at Blackrock / iShares showing that over the past 14 months the dominant buyers of longer-dated US Treasuries have not been private investors, but pubic institutions.  The iShares research states that since 2011, the Federal Reserve and the foreign public sector purchased Treasuries with maturities of at least 5 years in an amount that was greater than the total supply issued during the same timeframe.  More demand than supply = higher prices and lower yields.

In our minds, the answer to the Big Question is another question.  Will public institutions continue to be large buyers of U.S. Treasuries?

Current rates offer poor returns for investors but the market, after probably some period of adjustment (the up 1-1.5% in rates), can remain high (high equals low rates) for a prolonged period if the Fed continues to be accommodative and other governments and public funds that have mandates to buy sovereign debt continue to view the U.S. as the best place to park money on a relative basis.

Assuming the US economy continues to stabilize or improve, and there is no new Fed buying program, we expect the 10 year Treasury bonds to move up to a range of 3.0-3.5 sometime this year or early next.

After that, however, it is too early to tell whether large public funds (China, pension funds, etc.) will change behavior and tilt the market as a whole to a net selling position, which would probably cause a Bear Market in bonds.

So, what to do?

If you have not reset your expectations yet on what the Fixed Income portion of your portfolio will return in the future, please do.

Nothing is certain, but our money is strongly on the bet that returns in bonds will be flat to maybe slightly negative over the next few years.  This does not mean that investors should move wholesale out of bonds.  It just means that return assumptions and allocation tilts should be reviewed to make sure you continue to meet your goals.

As an action item, you might consider reviewing your current bond portfolio and work with your advisors or managers to make sure you are comfortable with your current interest rate exposure.  Ask what your average duration (interest rate sensitivity factor) is and if it should be lower.

Next, start looking at areas to add more diversification to your portfolio.  Should you look at different ways to invest in different capital structures and explore more thoroughly convertible bonds, floating rate bank loans, master limited partnerships, etc.?

Some might suggest Investment Grade bonds or Municipals might offer protection or be attractive.  As long as they are high quality this, however, is currently not the case.  Spreads or the difference between high quality bonds and US Treasuries are at or near all time lows.  If the yields are very close between bonds then they offer no spread or rate protection to interest rate risk.  It is true that High Yield corporate or municipal bonds might be attractive relative to high grade bonds, but always remember that a bond is a bond.  If rates move up, all bonds will be affected.

Finally, should you consider tactical allocation shifts from bonds to equities?  This is a harder call at this point.  Last Fall, it would clearly have been a home run.  Now with equities up double digits YTD in 2012 and talk of slower growth in some emerging markets and recession in Europe, are corporate profits and returns going to be lower?

Before we start a debate on the current attractiveness of equities, consider taking a look at the following links to pieces put out this week by GMO and Richard Bernstein:

GMO – What Goes Up Must Come Down

Richard Bernstein – The First Sign of Weakness in Corporate America

We tend to agree with Bernstein.  Continue to stay positive on Equities but focus more than some on portfolio strategies that target high quality U.S. stocks.  We also continue to favor higher income equities even though we are aware that they have lagged some other types of stocks YTD.

We hope this all helps and keeps the good questions coming.

Have a wonderful start to the week!