Wealth Clarity Blog

Hot off the press is the latest edition of the Highland Investment Snapshot; our best thinking on 2012 investment and economic themes and outlook.  As most investors are aware, this time in history is fraught with a tremendous amount of conflicting data and unique risks. In our opinion, this environment is creating some interesting investment opportunities for those willing to put the broad range of global economic and political concerns in perspective.  I hope you find our reading of the tea leaves to be insightful and helpful.

This link will take you there:  Highland Investment Snapshot 2012

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.

Each one of us has weaknesses to accompany our strengths, and blind spots to offset our well-honed skills and abilities.  Wealth creators are no different here, and in my experience the missteps often fall into two categories: Not planning, or not planning effectively.  Here is a list of the top 10 foolish mistakes that wealth creators make:

Not planning:  It’s painful, it’s not a priority, it’s not exciting.  It’s the “ostrich” approach (head in the sand)!  “Not planning” can sound like…

1.  “Why plan? It seems like I have plenty of money.”

It’s common for people to underestimate the amount of assets required to create financial independence. Overspending is a risk at all wealth strata, especially in the U.S.  Lifestyle costs keep increasing over time without any restraints, and this can rapidly deplete your resource safety net. This has been especially pronounced during the financial market declines we have witnessed during the past decade. So, be aware of lifestyle costs and choices, and know what level of spending your wealth supports.

2.  “I don’t have wealth management needs because I don’t have liquidity.”

This is the other side of the coin, and it is just not true, plain and simple.  Yes, you need liquidity at some point to pay for lifestyle and to enjoy your life, but many of the same planning issues need to be addressed regardless of whether you have a certain level of liquid assets.  Wealth creators, whether liquid or illiquid, need thoughtful wealth management. Continue Reading »

Join us for the special briefing “Preserving, Protecting, and Enhancing Wealth in The New Normal” hosted by the Highland Capital Management Investment Team of John Christianson, Dan McGilvray, and Jonathan Friedman.

July 29^th, 2010 from 12:00 to 1:00 PM (PST)

They will share with you ideas about facing “The New Normal” including:

• What is the “New Normal” and what does it mean to you?
• What is Highland doing to enhance our clients’ investments and their future?
• What might the future hold?

Please RSVP by emailing tina@HighlandCM.com by Tuesday, July 27^th.  We will then send you a link to the presentation.  If you have any specific investment questions related to this topic that you would like addressed during the webcast please feel free to send us your question(s) in advance.

We look forward to having you join us!

It’s the third Friday, which means it’s our third and last guest sports blog!

Guest post by Daniel McGilvray, vice president of investments, Highland Capital Management

During the U.S. Open at Pebble Beach a month or so ago, Dustin Johnson lost a three shot lead going into the final round on Sunday and actually ended up outside of the top 10. Justin Rose followed the week after at the Travelers Championship by blowing a three shot lead over the rest of the field and did not end up even coming in the top five. Both of them seemed to lose the strategy that got them to the top of the leader board in the first place. They went from making great shots to getting cautious to making horrible shots to try to make up for the cautious shots and losing the lead. Contrast that with what happened this past weekend with a virtual no name in golf: Louis Oosthuizen. He went into the final day of the British Open at St. Andrews leading by four strokes and actually EXTENDED his lead by a few strokes on the final day. While he adjusted his strategy to be slightly less risky, he stuck with his overall game and did not get too cautious.

It can be the same way at times in investing…we stray from our originally intended strategy because things get “too bad” or there’s a new “normal” or new “paradigm”.  At Highland, while we make tactical over weights or under weights at certain times, we work hard to come up with the right strategic targets for clients as the anchor to ensure that the underlying investments do not stray too far from target (high or low) and get too far away from the originally intended strategy. Without those “anchors” to make sure you don’t stray too far from the original strategy, you could easily end up losing all the gains you’ve made and possibly even going below what you originally had if there is no process to assure some money is taken off the table and gains are harvested (or that funds are added to those areas that underperform over an extended period of time).

In this manner, an investor can ensure that they do not lose the lead (or are unable to ever get back losses). An obvious example of this is the advisor/investor who gets conservative near the bottom of the markets or aggressive near the top of the markets. Bad timing in either account can cause losses to persist. So remember, stay anchored to your long-term strategy.

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.

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?

First, there is a huge sell-off in stocks starting in 2008; then, the big rally back higher this past year.  It really didn’t matter what stock you owned in either case as most moved in tandem. 

Now what?  In general, I would argue that stocks aren’t overly cheap; and, stocks aren’t extremely overpriced.  So, what do you do in this confusing time?

In a recent article in The New York Times titled When Stocks Stop Moving Like a Herd, Paul Lim gets it right in several respects:

It is easier to invest when all you have to do is jump in when everything is moving up, like the past year, and critical thinking about specific investments is less relevant.  Just get the direction right and you win…but that dynamic is changing fast.

The equity markets appear to be moving towards an environment that will reward those who can find value.  You can still purchase growth stocks, but it would behoove you not to overpay for them.

Active management can be a key contributor to performance during this type of uncertainty because of the opportunity to tilt your portfolio towards undervalued investments and adjust to new information.

The quality of your advisor will play a big part in the results you see over the next few years.  A well-defined investment process and experienced team is as important as ever.

Keeping Paul’s ideas in mind, I wanted to give you a few tips that could really help your portfolio results during the next few years.

1. Review how much of your portfolio is indexed versus actively managed — I would argue that a higher allocation to actively managed assets is appropriate in this uncertain economic environment.  Increasing volatility expands the chances of finding interesting opportunities.
2. Make sure your investment selection process includes a valuation screen and doesn’t just focus on growth.  If history repeats itself, we could see value stocks outperform growth stocks in the years ahead. (Note:  We believe our internal stock strategy of growth at a reasonable price is particularly timely in this type of economic environment.)
3. Evaluate your advisor’s investment philosophy and strategy — can they communicate it to you so you understand it?  Does it make sense to you?  Did they stick to it or did they abandon it during the recent financial meltdown?  What did they learn during the past few years and what adjustments are they making?  A high quality advisor is more important now, than ever.

Do you have any investment tips to add that you’ve been successful with?

A buzz phrase you may hear these days is “socially responsible investing” or SRI. 

Here’s a quick guide to what it is, why it’s important, and the different forms of participation.

 SRI refers to investing with a social conscience.  It’s not just about making money anymore: The SRI philosophy looks for opportunities that help a broad array of social concerns such as; reducing environmental effects, improving labor relations, or helping underserved communities.  At its core, SRI underscores the responsibility of corporations to function as good citizens in the global society. 

So what’s the big deal?  SRI has been around for several decades but the trend appears to be gaining momentum lately, and especially among wealth creators.  

In 2007, the Social Investment Forum, a non-profit organization focused on responsible and sustainable investing, conducted a study on SRI trends and found that $2.7 trillion of the $25.1 trillion in US assets under management employed some type of SRI strategy.  In addition, mutual funds with SRI screens (more details on screening below) grew from $12 billion in assets in 1995 to $202 billion in 2007. 

This pace of growth was significantly more rapid than the market growth as a whole.

More important than the potential opportunities and impacts of SRI as a trend in the markets, SRI is a way for investors, and specifically wealth creators, to align their social views and values with their investment assets.  In essence, it’s an opportunity to reward those companies that contribute to your definition of where society should be headed.

The umbrella of SRI covers many topics and strategies for investing, just as each individual expresses his or her social agenda in a different way. 

In general, there are three broad strategies for participating in SRI:

1. Screening – seeking or excluding companies based on specific, social criteria
   • Positive screening is searching only among socially responsible corporations when looking for investment opportunities
   • Negative screening is excluding companies that are socially irresponsible, but not necessarily socially neutral
2. Activism – voting proxies and lobbying corporations on specific social issues
3. Direct – providing funds to community-level projects and companies

SRI is a broad subject with many different ways to become involved.  As social awareness and social activism increase – and markets respond – SRI appears poised to play an increasing role in how wealth creators invest their money. 

In sum, your money can reflect more than just profit motives – it can express your social conscience too.

You have likely heard that 80%+ of portfolio returns come from asset allocation strategy or the way you diversify your investment assets.

So, naturally, lots of wealth managers spend a great deal of time carefully considering how to allocate portfolios for the “long-run.”  That kind of strategic thinking is important and if it’s done well then a portfolio has a greater potential to achieve its objectives over time.  However, we learned over the difficult past 18 months that long-term thinking did not eliminate volatility and preserve capital.

But, no one said that “strategic asset allocation” only applied to the long-run (3-5 years).  Tactical, or short-run (3-6 months), thinking provides the opportunity to respond to news and a changing market environments.  The tactical approach lets investors stay flexible and gives them a chance to verify that their initial thoughts on the market are playing out as expected and make the necessary adjustments that can enhance the outcome.

Being successful requires striking a balance between strategic (long-run) and tactical (short-term) thinking.  Both are valid, and both serve the needs and objectives of the portfolio.  The strategy provides an anchor so the tactics don’t stray too far or get taken to an extreme where they may be viewed as market timing; meanwhile the tactics help to take advantage of immediate, forward-looking opportunities that the strategy might miss completely because it tends to be focused on historical data.

The financial markets may be in a period of increased volatility without any clarity of information.  This can be a very difficult environment to stay locked into a static, long-term strategic allocation.

Key insight:  combine strategy and tactics for better results.

It’s the same 80%+,  and it takes more skill and focus, but the time required can be worth it.  The skill necessary to provide tactical insights will prove to differentiate wealth management firms in the future.