In This Issue…
It is no secret that I believe that active management is superior to passive buy-and-hold investing.
One of my initiatives as President of the National Association of Active Investment Managers (NAAIM) this past year has been to raise the issue of a trillion dollar flaw in traditional financial advice – that it completely ignores active management, and increases risk in doing so. Trying to create change in a huge industry is no small feat.
My goal is to have diversification by strategy accepted as a risk reducing mechanism just as diversification among different asset classes, such as stocks and bonds, is recognized as a way to lower risk.
I believe that every investor should have at least a portion of their portfolios allocated to active management, just like they should have some stocks, some bonds, some hard assets, some international investments, etc.
I actually began this mission in 2002 when I wrote to the Certified Financial Planner Board of Standards suggesting additions to the
The CFP Board, currently home to over 59,000 CFPs, in 2002 had an authorized curriculum with over 1800 topics, only three of which were remotely related to active management. I had hoped my nudge would encourage them to include a few more active management subjects in their curriculum.
I was told, politely, that the Board thought 3 out of 1800 was plenty.
Disillusioned, I dropped my CFP designation a few years ago after a 12 year membership. While the CFP Board may not exactly be
Why does my industry resist active management despite its success? Because active is much more difficult to execute than a passive buy-and-hold strategy. The back office functions are different and complex. There is an added layer of skill required of the practitioners when compared to ordinary mutual fund and annuity sales people.
Also, it takes a lot of time to monitor your investments every day. Many investors falsely assume their traditional brokers or planners are watching their investments for them. But how many of them moved those investor’s money to safety before the market went in the tank last year? Not very many.
The bottom line is that the businesses of most brokerage and planning firms were designed in the 1980s and 90s around buy and hold. They are not equipped to handle actively managed accounts and they don’t want to take the time, hire the extra help or spend the big money to change their systems.
The absurdity of traditional advice was made clear in the July 20, 2009 issue of BusinessWeek. In an article called Retirement: The Big Rethink, two industry pros were highlighted in ways that exposed the fatal flaw of traditional financial planning advice.
Rockford, IL Financial Planner Theresa Harezlak tells BusinessWeek that her traditional advice to remain 100% invested in stocks, destroyed her children’s college funding, but her buy-and-hold discipline has her staying the course.
I am reminded of the tongue-in-cheek definition of insanity: Doing the same thing over and over and expecting different results.
Christine Benz, The Director of Personal Finance for investment analyst Morningstar, confessed that she “had been trying not to look at her retirement accounts” during the last year’s downturn, and I think I know why.
The article mentioned that Ms. Benz kept 60% of her portfolio in stocks and went so far as to name her 10 holdings. As expected of a top person in the firm all were mutual funds with high Morningstar ratings, plus some Morningstar stock. Hers was a textbook case of investing in the way Wall Street suggests.
Assuming an equal amount of each holding, data provider FastTrack shows the equities in Benz’s account would have lost a stunning 52.83% of their value between Oct 9, 2007 and March 9, 2009.
Benz acknowledged that helping friends and family not make bad decisions, “like moving to cash”, was stressful. I can understand her stress when friends were looking to her for advice and the best she could offer was a seat belt for their deck chair on the Titanic.
Is this the best that the “traditional” side of the industry can offer? From a top dog, even? God help us all!
I would think that the non-traditional, active management might be looking a little better to them after their experiences of the past year or two.
Only time will tell if I will be able to get the industry to shift its direction a bit. But I love a challenge and I certainly think this is a worthwhile one.
In the mean time, don’t take any wooden nickels and question all “traditional” financial advice.
These are the same funds I have used very effectively to reduce portfolio risk since the year 2000 with a technique called hedging. These have always been small, very short term holdings for my clients and contribute much to the low risk that HCM clients enjoy in their accounts.
I am amused that despite a 10 year history, many firms are just now realizing that these trading vehicles are professional tools and do not act like ordinary investments. However, the firms had allowed their brokers and planners to sell them to individual investors without really understanding the math behind them, resulting in large losses for many investors.
A little knowledge can be a dangerous thing.
At the same time I am concerned that these same firms that didn’t understand what their representatives were selling may try to manipulate the regulators into outlawing these products altogether.
That is sort of the M.O. of the industry. Throw the baby out with the bathwater – especially if it keeps us professional money managers from increasing our advantage over their retail brokers.
This is one of the fastest developments I have ever witnessed sweep through the industry. It will be interesting to watch it unfold.
However, on Friday, August 21 the major indexes** broke through their ceilings and it now looks like the uptrend that began in July may just continue.
If we get some follow through to last week’s rally, I may put some of our cash back to work . However, September has a reputation for lousy stock market performance, so I will be more conservative for a while than I was last spring and retain some cash in case I quickly want to put a protective hedge on our portfolio values.
After a 50% run-up in some indexes, and the added seasonal risk of being invested during the September-October time frame, the overall risk is currently higher than it was last Spring.
We must keep in mind that the long term trend of the stock market is still down, and bad things can happen in down markets. This is not a time to be charging blindly ahead, so 70% invested in growth seems about right at the moment.
Current holdings in the Careful Growth* accounts include high yield bonds, international and U.S. value, Latin America and Australian funds, and a big chunk of cash.
Our Flexible Income* accounts are still fully invested in high yield bonds. High yields are again showing signs of slowing down after six hot months but are not yet saying “sell”. I wrote a month ago that we came very close to a sell signal on high yields in early July, but my discipline to not predict signals and act too early served us well when high yields turned back up and gave us another nice gain.
And the risk of high yields is very low. The total decline from the price peak 10 days ago is only 1.58%. When that small decline begins to make me think of selling, you know you are in a low risk investment.
August 25, 2009
Will Hepburn is a well-known expert on investment analysis and portfolio management.
Mr. Hepburn is president of Hepburn Capital Management, LLC, a Registered Investment Advisor, Chairman of the Board of NAAIM, the National Association of Active Investment Managers, and he is an instructor at Yavapai College in Prescott, AZ.
A year ago, the investment world was beginning to change in a big way, resulting in one of the greatest stock market crashes in history. If you were not yet an HCM client, what kind of advice would you have liked to receive back then?
Here is what I was telling readers of my Money Matters newsletter during the months prior to the crash of 2008.
August 12, 2008
This is probably not the end of the bear market, however, and at some point a barrage of bad economic news will end the current market rally. I’m not being a pessimist, but a realist. My working assumption is that we are in a recession and a bear market for stocks.
Sept 4, 2008
I think the outcome will be a continuation of the bear market. Perhaps after the Labor Day weekend we will be able to tell more.
For now, capital preservation should be high on your list of investment objectives.
Sept 16, 2008
The models* which our managed accounts are patterned after have not changed for several weeks now. Capital preservation is the watchword.
Our growth models* remain heavily hedged to protect against a market decline. The effect of the hedges is like having 70% in cash.
Oct 1, 2008
Hold only high quality investments that can be converted to cash and moved on short notice as defaults from banks could bleed over into insurance companies and businesses with weak credit. This is the way we run managed accounts for our clients, and we do it for a reason.
Importantly, both our growth and income strategies are currently 100% in the cozy comfort of a 100% all-Treasury money market fund so that neither you nor I have to worry about the market getting more negative over bailouts and bailout politics.
October 14, 2008
Our headline neatly summed up the market environment back then:
What the Heck was THAT??
So, how did we do during the crash of 2008? Don’t tell us, tell your friends.
2009 Fall Class Schedule
Basic Investing For Retirees
September 16th – 24th,
Wed. & Thur.
1:30pm – 3:30pm
FIN100 / F061 $75.00
Advanced Investment Analysis Using Charts
September 30th – October 1st, Wed. & Thur.
1:00pm – 4:00pm
FIN101 / F062 $65.00
For details or to register call Yavapai College 717-7755
or visit Yavapai College Online
On August 17th, my wife Cathleen, who is in charge of the vocal instruction department at Yavapai College, received the 2008-09 Innovative and Creative Teaching Award for the way she has reorganized her department and streamlined and standardized the grading system for voice students at Yavapai.
Also, if you like Meryl Streep, you will love the movie Julie and Julia, a wonderful story about Julia Child’s beginnings as a cook. It is in theaters now. Cathleen and I give it two thumbs up, with an empty-popcorn-bag kicker.
The Riddle of the Week
I have holes in my top and bottom, but I still hold water. What am I?
The Riddle Answer
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* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
Information in this newsletter is derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.
In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Hepburn Capital Management, LLC, adapt to changes in the markets by changing the investments they hold. Therefore, comparisons to broad stock market indexes such as the unmanaged indexes listed above may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares are not insured by the FDIC or any other agency, are not guaranteed by any financial institution, are not obligations of any financial institution, and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, a Registered Investment Advisor. HCM will not transact business unless properly registered and licensed in the potential client’s state of residence.
Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.
Copyright (C) 2009 William T. Hepburn. All rights reserved.