Money Matters Newsletter:
April 7, 2015
The Robots Are Coming! The Robots Are Coming!
The Investment View from Prescott, Arizona
The latest industry buzz is the development of robotic trading platforms by the big brokerage houses. What could be simpler than filling out a questionnaire and having the magic of powerful computers ensuring that your investment objectives are being met.
Robo advisers use “smart beta” investments or fundamental indexing. These are passive investment styles that follow mathematical algorithms in the hopes of getting a big return with, hopefully, less risk.
What’s not to like about not having an adviser to pay, having lots of math showing that the path you are on is statistically a good one for you, and no pesky broker phoning you, wanting to sell you something.
These automated robo portfolios are the latest investing trend to catch the eyes of investors – and they are catching the eye of regulators, too.
Why would regulators be looking at something as attractive as robo-investing? Because they are being sold as a panacea that masks significant market risk. Not everything can be neatly programmed into a computer. The world evolves and large swings in the financial markets can be caused by events no one has ever seen before. Robo advisers are certainly not a replacement for a hands-on human who can look at the markets and say “this time things are different, we should move out of the market”.
What jumps out at me in the definition of algorithmic investing is the word passive.
Think about the last two big bear markets. The S&P 500 Index** dropped 52% between 2000 and 2003 as the market reeled from a technology bubble. The world had never seen anything like this happen, so how could it have been analyzed and responses pre-programmed into a computer? It couldn’t. Ditto for events occurring during the financial meltdown of 2008.
One of the earliest “smart beta” funds was Guggenheim’s Equal Weighted S&P 500 Index** Exchange Traded Fund (Symbol: RSP). Although it has outperformed the standard S&P 500** since its inception, it lost 59.93% during the 2007-09
bear market, more than the S&P 500**.
One reason smart beta funds don’t always live up to the big reward hype promised by their issuers is that they make minor adjustments but keep you fully invested during major market declines. Passively holding this type of investment may have you experiencing life changing financial losses during the next bear market decline. But at least a robo-adviser will make it easy to do so.
In 2001, I was in Denver interviewing Brian Haywood, then the manager of the Invesco Telecom fund, the largest telecom fund in the business back then. I believe in the great American investment creed of selling high and buying low, so I questioned why he was staying fully invested during the huge market decline that was underway. Brian told me that when someone is invested in their fund they assumed the investor wanted to hold telecom stocks, and if the investor wanted to be in cash they were expected to withdraw from the fund.
How many times have you ever had your adviser or planner say that you should withdraw from an investment and sit in cash? Probably never, because that is not their job. They are paid to put you into investments, not get you out of them.
Robo advisers will put you in investments that are working right then, but the problem is that if the market changes and being invested at all is not a good idea, the robot becomes a recipe for disaster because it will keep you fully invested. It may move you from one stock sector to another, but that is a lot like changing seats on the Titanic, you’ll still be going down!
The problem with automated robo-advisers is that they do not respond appropriately to changes in the markets and most investors using them do not understand this.
What I mean by appropriately is responding to changes in investor (your) sentiment. If you fill out the robo-adviser’s questionnaire in a good market your answers will be different than in a bad market. But most advisers, robo-advisers especially, take that one snapshot of your views towards risk and apply it all of the time. They simply do not have enough manpower to call you and see if you would like to change your investment objectives, so they don’t.
Hepburn Capital is one of the few players in the industry who stands ready to get you out of investments when they are in harm’s way. Our trademarked strategies that Adapt to Changing Markets® are designed to fill that gap between what you expect and what large financial houses are set up to deliver. We stand ready to change the strategy to become more conservative when we believe that move will benefit you.
So if you hear the Siren’s song of an automated trading platform or robo-adviser, remember, it’s not what they can do, it’s what they can’t do that you should look out for.
The Women I Work For
I rarely fail to get a smile when I mention “the women I work for”. These are the four women who make things run so smoothly at the office. I enjoy my work enough to want to do if for another 20 years largely because of these ladies.
Laurel Taylor Fitzhugh has been with Hepburn Capital for the past 10 years, starting out as my office manager and easing into the role as Technology Coordinator as she wanted to cut her hours back. Laurel does much of her work from home in the middle of the night, but lately has been in our front office one day a week, too.
In addition to keeping our website looking good and our computers working smoothly, Laurel gets the tasks of exploring new ideas and new software for us.
February’s area wide Internet outage was a real eye-opener for us. We keep three different technologies for accessing the Internet since being able to trade and protect your money through thick and thin is a responsibility that we take seriously and the Internet is crucial for that.
Little did we know that both our CableOne and Century Link DSL lines use the same Internet “backbone”, so both went down at the same time in February when the fiber optic cable was cut. Fortunately, I was meeting clients in Phoenix that day and was able to connect to the Internet with my cell phone’s data connection and conduct business as usual.
After that incident, I tasked Laurel to find another Internet provider that had fully independent technology to provide the redundancy we were looking for. Surprisingly, Dish Network also uses the same Internet backbone as cable and phone companies. Only one company, Hughes Networks, uses a totally separate satellite technology than the other services.
So when you come by the office and see our new satellite dish on the roof, you’ll see evidence of our on-going commitment to serving our clients and of Laurel’s good work.
Thank you, Laurel.
Don’t Keep Me A Secret
My style of investing – an active management approach, doesn’t have to outperform a rising market to produce better returns than a buy-and-hold approach, as long as it outperforms in declining markets.
Overall, Hepburn Capital strives to deliver satisfying returns while avoiding life changing losses better than a buy-and-hope-it-works-out style of investing.
If you haven’t noticed, you have a remarkable investment adviser with a truly impressive background working for you: Past President of the National Association of Active Investment Managers, a former mutual fund manager, and a leader in creating innovative investment strategies that Adapt to Changing Markets®.
You can earn discounted management fees with your referrals, so when the subject of money comes up with family or friends, please don’t keep me a secret.
How Are The Markets Doing?
The stock market, represented by the S&P 500**, has been flat this year through March 31st with a 1st quarter gain of only .44%. It is being held back by weaker earnings from US companies, spillover from the European recession, and poor job growth in the US.
The Dow Jones Transportation Index has stalled over the past 4 months and begun to break down. This is troubling since it is often the first place market corrections show up. Transportation stocks – railroads, trucking companies and airlines – have to carry raw materials to factories and finished goods to stores or consumers. If demand drops off this is where it is first seen.
Foreign stock markets did begin to recover a bit, which I assume is a response to lower energy prices. Since Europe and Japan import much of their oil, lower prices are a big relief to their economies. Significant problems continue in Latin America, as that index (symbol: ILF) remains the weakest of the major stock market segments.
Gold continues to confound and frustrate the gold bugs. The bounce that began in November fizzled out and gold is once again close to its lowest price since its peak in 2011. One nice benefit of gold’s slide is that the number of gold ads we are bombarded with has dropped way off. Thank God for small favors, huh?
The bond market gave us positive returns during the first quarter as interest rates have zig-zagged downward a bit this year. Although yields on the industry bell-weather, 10 Year Treasury Bonds are lower than a year ago, they remain higher than the lows of 2012, keeping intact my theory that we are in the early stages of a 30 year uptrend in interest rates.
The real estate market appears to be cooling off again both locally and nationally after a couple of good years. I don’t expect another real estate crash like we had a few years back, but the pent up demand for real estate built up during the crash seems to have been satisfied and the reality of so many unemployed or under-employed folks not being able to afford homes seems to be settling in. Fewer buyers mean less upward pressure on home prices.
We seem to be in a Goldilocks market, not too hot and not too cold. Technically speaking (looking at those charts and graphs that look like a foreign language if you are not familiar with them) the markets are holding up reasonably well considering all the adversity surrounding them. I like to let the technical picture be my guide because it is based on what is actually happening, not conjecture, speculation and blather about what might happen that is seen on so many TV stations, blogs and newsletters.
Since the only thing we can count on is change, this means the markets will either heat up or cool off from here. At Hepburn Capital, we are prepared to react either way. Stay tuned . . .
What’s Going On In Your Portfolio?
Our Shock Absorber Growth* strategies, currently using 3 different underlying strategies, outperformed the S&P 500** during the six months ending March 31st, and took less risk in doing so. That is a great result!
Last summer we changed the Shock Absorber Growth* strategy to adapt to changes I was seeing in the markets, adding the Impact* strategy to client accounts in June and our Future Technologies* strategy in August. Both have worked very well since inception.
Impact* uses an aggressive Nasdaq** index fund that we hop in and out of. Since its inception on June 12th we have had 5 round trips (buys and sells) with 4 being profitable and one producing a 3% loss. As of March 31st, the net gain from this strategy is over 13% while the S&P 500** gained 7.14% during the same period. Only about 1/3 of our Shock Absorber Growth* portfolios are allocated to this strategy, but it is really helping our performance.
The Future Technologies* strategy has also outperformed the S&P 500** since its inception in client accounts on August 19th of last year and comprises a little over 1/3 of Shock Absorber Growth* accounts. It holds stocks in nano-technology, stem-cell and genome research, robotics and Internet of Everything companies.
The balance of Shock Absorber Growth* is in health care, consumer services and growth funds and stocks. Although this portfolio has changed over the past few quarters, the current holdings show a risk reward profile that indicates it is positioned to do well.
Flexible Income* portfolios also did well during the 1st quarter, producing positive returns from our high dividend holdings.
Strong performance in January and March allowed Municipal Income* accounts to overcome February’s weakness and produce good returns for the 1st quarter.
College Classes Coming…
Will’s next classes at Yavapai College will begin in June. We will have more details in next month’s newsletter.
Scottsdale Office
If it is more convenient to meet with Will in Scottsdale, please call the office to schedule your appointment.
928-778-4000
Our Spotlight Strategy
With our Adaptive Growth Strategy we strive to provide high total return from a combination of investments from both the equity and income markets with the emphasis on equities.
Our proprietary Stock Market Exposure Indicator is used to determine a stock market exposure that adapts to the strength or weakness of the market, directing exposure in the HCM Shock Absorber Growth strategy to range from 20% to a maximum of 80% of account value. The balance, 20% to 80% is invested using the HCM Flexible Income strategy. The HCM Safety Net
indicator is designed to warn of sudden potential declines in which case stock market exposure is quickly reduced.
Mental Floss
Prevent soil from escaping through the holes in the base of flowerpots by lining with large coffee filters.
Updated Form ADV
Our newly updated SEC Form ADV, Part 2, the federal disclosure document which details key aspects of Hepburn Capital’s business, is now available on our website, along with our current Privacy Policy Statement.
If you would like a current copy of either of these documents, they are on our website at https://www.hepburncapital.com/PR/form-adv.pdf and https://www.hepburncapital.com/images/PrivacyPolicy.pdf respectively.
If you would like a current copy of our Privacy Policy or our SEC Form ADV, Part 2, you can find them at our website at www.hepburncapital.com/images/PrivacyPolicy.pdf or www.hepburncapital.com/PR/form-adv.pdf respectively.
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Performance and 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.
** Indexes are unmanaged lists of stocks considered representative of a broad stock market segment. Investors cannot invest directly in an Index.
Flexible Income
Adaptive Balance
Adaptive Growth
Shock Absorber Growth
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be 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 mentioned 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 and other investments used in our managed accounts are not insured by the FDIC or any other agency, are not obligations of or guaranteed by any financial institution and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, an Arizona Registered Investment Advisor. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.
Copyright (C) 2014 William T. Hepburn. All rights reserved.
