Wealth Clarity Blog

Our recent investment snapshot posed this question: “Is the current economic crisis a ‘soft patch’ or the beginning of a double-dip recession?”  I’m starting to wonder if we aren’t instead in a mud puddle.  I recently heard this term used to describe the space between soft patch and recession, and it resonated with me.

In short, our economic outlook is messy – muddy, in fact.  Yesterday’s stock market response showed some of the pent-up concern and frustration with our political circus, our persistently stuck unemployment, and the slow (or absent) economic growth that is lingering like a fog over any sense of confidence.

Is this “Groundhog Day” as it relates to the recessionary period starting in 2008?  Are we heading back towards a repeat of that time frame?  I really don’t think so, primarily because the backdrop is different this time around.  The consumer has taken steps to deleverage and in fact is saving more; businesses have gotten leaner and are generating decent levels of cash flow; and economic indicators including auto sales, home starts, and unemployment are already hovering near their lows.  It doesn’t mean they won’t move lower, but our economic dashboard is already anemic and that isn’t news.  (One important caveat: the European debt crisis could continue to have material global effects.)

Objectively, equity valuations are below historical averages on a price to earnings basis, and the earnings yield (inverse of the P/E ratio) is trending well above 10-year Treasury rates.  This is something even Warren Buffett likes to see!  When compared to other investment alternatives, including negative real rates of return on money market funds, growth assets should not be arbitrarily put in the dog house.

I have found that one healthy way to look at your portfolio is to use the following exercise:  assume that your portfolio is sitting in cash today instead of the current positions you may hold.  Then, look at all of your possible investment alternatives from a risk and return standpoint and ask yourself how you would you allocate the money if you had to right now.  Many times investors can get anchored to their existing holdings too strongly, especially when viewed through the lens of trading costs, unrealized gains/losses, and taxes.  If you try to position your portfolio using the approach above, you can minimize the emotional challenges of making investment decisions.

So, here are a few investment keys for working through this financial mud puddle while keeping you moving towards your goals:

1.  Focus on fundamentals more than you focus on the news—now is the time to hone in on the facts and not get blown around by the ever increasing list of “experts” espousing fear (in most cases.)

2.  Stay agnostic about the investment choices you have—remember that interest rates are at historically low levels, and cash is paying virtually nothing.  This isn’t the case in equities, nor in a few other spaces.  I’m not suggesting increasing your risk posture without great consideration – instead, focus on objectively seeking value where it exists.

3.  Don’t change your investment philosophy or strategy now—my experience has shown that successful investors hold tighter to their investment approach during times of uncertainty.  Better to have an approach and philosophy that you believe in (even if it’s not perfect) than to not have one at all, because the damage caused can be material.

4.  Be nimble—the world changes quickly, and the pace of change continues to increase. Make sure that your investment approach has the ability to make tactical shifts as new information emerges.

5.  Favor quality and cash flow in this potentially low growth environment—going forward, as noted in previous posts about the “New Normal,” adjusting your return expectations downward and looking at cash flow as an important part of return will be critical.  Don’t get seduced into reaching for yield or outsized returns.

How can you work through these types of world stress points?  Be resilient.  Be a survivor, and not a hero. Feel free to contact me if there is a specific question you would like me to address.

If you missed our webinar earlier this month, you’re in luck!  Click this link for playback of the Preserving, Protecting, and Enhancing Wealth in the New Normal webinar. Slides, audio, and tips.

Sorry you missed the ‘live’ webinar, we’ll let you know when our next one will be.  In the meantime, do you have any questions or feedback for us?

A few people have recently expressed concerns to us about market volatility and where the economy is heading. Other people have asked us what options are available to help drive portfolio returns in the midst of such low yields on bonds (the two year Treasury yield recently hit its lowest point ever at 0.6 percent and the 10 year yield is now below three percent). Alternative assets, which we have built into client portfolios over the past few years, are a natural solution for reducing portfolio volatility and boosting returns. As a firm, Highland now has approximately 20 percent invested in alternative assets and even our most conservative clients generally have 10 percent or more of their portfolio exposure in alternative asset classes. Over the past quarter in fact, most of the alternative asset classes were down ½ or less than the equity markets and some (specifically gold and certain hedge funds) were actually up.

We wrote a white paper as a primer on alternative assets, which generally help mute portfolio volatility due to their low correlations with traditional asset classes. As mentioned, they can also help bolster returns. Alternative assets do have some drawbacks: namely, they tend to have longer investment horizons, involve higher risk at times, and have less liquidity than traditional asset classes. In the past the cost of participating in alternative investments was prohibitively high, however, there are now more options that allow investors to participate at lower dollar amounts. If you’re curious about alternative asset classes and what role they play in your portfolio, the white paper is a good introduction for how these asset classes behave and a description of the mechanics for making investments.

If interested in the white paper, shoot me an email (info@highlandcm.com) and I’ll send it to you for free.

If you think getting a loan secured by your home, either a home equity or first mortgage is a piece of cake it might be time to think again.

Over the past several months I have run into several client scenarios where the assumption was that getting mortgage financing for a new home, or to refinance an older mortgage, was a no-brainer. In two recent cases loans were denied where there was significant income (i.e. north of $250,000 per year) and plenty of liquid assets (i.e. well over $2 million); one client is a senior executive at a major technology company.

You might be saying, huh?

Well, in the brave new world of banking, it is more prevalent than you might believe. To get the bottom of the story and why it is happening with increased frequency, I contacted my good friend Robert Wuflestad, who is a very experienced mortgage banker, for some answers.

So, Robert, what is going on right now in the banking world that’s causing so many wealth creators grief?

The simple answer to this question is the industry is still in recovery. The fed is propping up conforming and government loans, but the mortgage crisis virtually wiped out the secondary market for Jumbo mortgages and non-conforming mortgages. Without this secondary market, there is little choice or competition and borrowers are limited to the institutions that have money to lend. Since many of these institutions are still trying to recover from their own problems, they are only willing to lend if they are certain there is little risk AND they are going to make a profit. This gets rather silly at times especially with the big banks because they can be extremely rigid in what they will allow. Competition is emerging and there are some attractive programs available through institutions other than the big national banks, but borrowers must still be able to document income and assets, common sense has been abandoned. Credit scoring can be challenging and you must manage this prior to entering the market.

It appears to me that high levels of assets, even if they are liquid, no longer matter. Is that right?

To get the best rates, if you have the required minimum of assets, generally it doesn’t matter how much more you have. You still must meet the required income, credit and property requirements. The idea of “common sense” guidelines have died, may it RIP.

There are a few regional banks that will lend on the strength of the borrower, but rates may be a bit higher, but even they have to be concerned about new regulations designed to protect borrowers from predatory lending and putting borrowers in position where their income cannot support their debt.

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Wealthy individuals are increasingly more negative about our global economic situation according to a recent study by Barclays—women more than men, developed countries (like the U.S and the U.K.) more than emerging economies, and as wealth increases so does the pessimism. 

It wasn’t that many years ago that here, in the U.S., we professed a can-do attitude that we could build, accomplish, and thrive regardless of the economic backdrop.  We talked about perseverance, ingenuity, creativity, world leadership, and all with some degree of unbridled optimism.

Notice in the article that the emerging economies are showing less negativity than the developed.  Why?  I would argue that they are seeing the growth and optimism and focus on creating a future that we used to espouse.  Much of this shift strikes me as a reality but it’s also sad.

So, I ask you again to consider…are you too negative?

Just for fun, let’s recap the stock market this year:  fantastic start, up almost 10% through the end of April; four days of losses last week primarily caused by the turmoil in Greece, growing concerns in the Euro area, and fears of tightening economic markets in China; the now infamous trading glitch and the associated historical price swing; and then yesterday’s surprise European Union rescue package valued at almost $1 Trillion that helped push equities higher to the tune of 3 – 7% in most developed countries.

Summation:  Basically your investments are back to even for the year.  Isn’t it easy to get complacent in your investment approach and then suddenly get reminded how quickly things can change.  You definitely don’t want to be figuring out investment process and strategy during times of high volatility and market stress. 

While some experts have suggested that diversification is “dead”, we believe diversification is back and represents one of the key themes we are focused on in 2010.  It was proven in 2008 when we were facing economic collapse, it was proven in 2009 when the financial markets rose from the ashes, and, we believe it will again be the case this year.  It is simply what preserves wealth and provides the best opportunity for increasing portfolio values during extremely uncertain times…like now.

Several of Highland’s other investment themes that are also relevant at this stage are: 

1. Quality is King: Although not as apparent during the first quarter, rising volatility has pushed investors toward quality investments.  For example, the purchase of U.S. Treasury securities that has in part been prompted by concerns about the stability of the Euro. 
2. Where’s the Yield: Yields are low due to this flight to safety, requiring greater diligence to locate reasonable quality income streams, especially with money market rates hovering near zero.  High dividend paying stocks, corporate bonds, and emerging market debt securities are reasonable considerations in this environment. 
3. Limited Visibility: Market movement is based on only the very latest data releases—think last Thursday—and highlights the need to be nimble.  Volatility is peaking and suggests a focus on proven process in investment selection and timing.
4. Developed Markets Owe: The potential for contagion in Europe and spill-over effects on the rest of the world is the reason we have reduced our exposure to Euro denominated debt and equity exposure during the past quarter as this crisis was brewing.  Most of our portfolios have less than 10% total weighting in Euro-denominated investments. 

What worries you about your investments during the second half of the year?

David Swensen, the brain behind the well-chronicled success of the Yale Endowment investment portfolio, pioneered an approach that pushed the boundaries of traditional portfolio management.  By adding large concentrations of illiquid assets (real estate, private equity, hedge funds) to the traditional liquid portfolio, he produced excellent results, especially during the tech bubble of 2000.

As you might have guessed, just about the time individuals and large institutions started copying Yale (and Swensen), the strategy had a tough year last year and produced large losses.

Why the Yale Model of Investing Doesn’t Work for Everybody – Justin Fox – Harvard Business Review

I recently read this insightful blog post by Justin Fox at Harvard Business Review and took away five key points that I thought wealth creators could benefit from and I’m sharing them with you.

1. Don’t chase yesterday’s stars — By the time the strategy is well documented and discovered and lots of money has poured in, the excess return provided by the approach is usually gone.
2. Keep learning— Swensen and team don’t keep static portfolio allocations.  Theirs isn’t a buy-and-hold-type approach.  The strategy stays the same, but they adjust their portfolio allocations to match what they believe will happen in the future based on research, judgment, and experience.
3. Stick with it— One of the reasons that Swensen (or Buffett for that matter), is successful is that he has developed a strategy for investing and he has the patience and gumption to stick with his approach and believe in it over the long term.  One bad year doesn’t cause the strategy to change.
4. Trust is required — Find a good, smart person (or team) to run a strategy, especially a person who is in it for the long haul, and then don’t dwell excessively on quarter to quarter results.
5. Design the strategy for your needs — Yale’s model works partly because it is good for Yale.  It was designed and executed for their needs and requirements not someone else.

How does your portfolio strategy stack-up to this?

Even as the economy appears to be stabilizing, there are still plenty of reasons for investors to worry: uncertain markets, continuing bank failures, a changing regulatory environment, persistently high unemployment rates and home foreclosures, and more. I spoke about this in a video earlier this year.

The three key points for people of means to know at a time that provides so many opportunities to worry:

• Don’t make any decisions based on short-term market moves or dramatic news reports
• Find a financial advisor you trust
• Keep your eye on your long-term goals

All easier said than done. Our Wealth Clarity System is designed to help create and sustain a long-term financial strategy based on your specific circumstances and goals. Our clients have found it’s particularly useful to have a plan like this in place during uncertain times.

If you’d like to assess your current state of clarity into your financial matters, you may want to download this 10-item checklist. (It’s a one-page document for you to print out and use, not something that asks you to input any information online.)

And for additional thoughts on how how to manage in difficult times, you may want to read my post from earlier in the year, “Three Success Strategies for Scary Times.”

How does a long-term investor keep perspective in a world that is driven so significantly by short-term events? This question has taken on added importance with the recent events in the world financial markets. As I write this, however, I am thinking about more than just the recent events. I’m thinking about the “crises” we’ve seen before, and the ones we are sure to see in the future.

I was driving my thirty minute commute to work last week on a day after more bad economic news came out about jobs and loss of national equity. It was interesting to observe the world without the filter of CNBC, CNN or Fox News telling me how I should feel. I know this runs the risk of sounding overly simplistic, but it was a refreshing experience to be unplugged and to see the world through my eyes rather than a media filter.

Construction workers were busily working at constuction sites

The streets I traverse daily on my commute were being torn up by large work crews ready to lay new asphalt.

The Starbucks line was just as long as normal when I arrived to order my tall drip coffee.

Cars scurried into parking garages as attorneys, CPAs, insurance brokers, and dentists all went to work.

In other words, life was still moving in a normal fashion as people went about their lives. I am not being Pollyanna or naïve towards this crisis – just attempting to untangle the “real” crisis and problem from the one that is spun through the numerous communication mediums and talking heads.

As a way to bring clarity to the situation, let me offer the following three suggestions: Continue Reading »