The difficulty lies not so much in developing new ideas as in escaping from old ones.
John Maynard Keynes
Our insights, reflections and musings on the most timely topics relevant to managing your investments.
Over the years I have written a great deal about the various problems in my industry. I have discussed the flawed structure of the retail brokerage world, the lack of training of the vast majority of “financial advisers,” the layers and layers of fees, and the conflicts of interest. I also have discussed the psychological…
First and foremost let me say that our thoughts and prayers are with the people of Japan who continue to suffer in this awful tragedy. I know I have shared this story with many of you before, but any time my job forces me to focus on what is often the cold, hard reality of…
This may come as a surprise to some of our clients, but Iron Capital does not have a monopoly on economic or market insight (wink, wink). There are a lot of very smart people in our industry, and Wednesday night we had the honor of hearing from two of them. So I thought we would…
Originally I cited another piece of my anatomy, but this is a family newsletter. The bizarre weather week we had in Atlanta has finally come to an end, and everything is back to normal. The streets are clear, mail is running, and even the Falcons resumed normalcy and will be watching the remainder of the…
Clients and friends, The Blizzard of 2011 has wreaked havoc on the city of Atlanta, particularly with ice-covered streets. Schools and business are closed again today with Georgia under a state of emergency, and most of the Iron Capital staff is unable to get into our office safely. Fortunately all personnel are fully capable of…
Over the years I have written a great deal about the various problems in my industry. I have discussed the flawed structure of the retail brokerage world, the lack of training of the vast majority of “financial advisers,” the layers and layers of fees, and the conflicts of interest. I also have discussed the psychological mistakes investors make – the desire to fit in, which leads to following the crowd into asset bubbles, and in some cases scams; the desire to not admit mistakes, which leads to holding on to losers far too long; and the overconfidence in investing in areas where one feels comfortable, which leads to under-diversification and the taking of undo risk. I have written about all of these issues and more.
However, not until this week had I seen evidence of how much these phenomena collide. Somehow I got on an email list for an industry newsletter called, originally enough, “Investment News.” Usually its content is nothing but garbage, but this week a title caught my attention: “Advisers Not Charging Enough.” The article was based on a study by a software firm PriceMetrix Inc., which provides practice management software to the adviser community. They studied the fee arrangements of fee-based financial advisers and found that there does not seem to be any rhyme or reason to the fees charged.
PriceMetrix said that finding was their biggest surprise, but that is not a surprise to me. What was surprising – in fact shocking – to me was a statement made by Doug Trott, CEO of PriceMatrix, who said, “Those advisers doing the most business tended to charge more.” He went on to discuss the difficulty advisers have in raising their fees, and here was another shocker: the advisers who were successful at raising their fees were the ones who charged more than average from the start. An even bigger surprise: advisers who raised fees opened 25% more new accounts than advisers who lowered fees. Mr. Trott’s advice to advisers, “The message from the data is that advisers should charge more.”
Relax. Iron Capital is not about to take Mr. Trott’s advice. We have set our fees based on the hurdle rate we believe we can get over to achieve our goal of providing you with market-beating investment results over full market cycles. Nothing kills returns like fees, yet the retail investor still seems to be blind to them.
It has always been shocking to me how people choose an adviser. We have been very fortunate at Iron Capital in that we are the largest fee-only adviser in Atlanta even though the other firms in the top-ten have been around a lot longer. Still, if one were to ask me about the hardest part of my job, I would say it is getting new clients. I have always been amazed at how people like Bernie Madoff were able to gather so many assets running a scam. Yet it is not just the Bernie Madoff’s of the world. I have recently been talking to some people interested in joining Iron Capital. Their firm has fallen apart, largely because one member of the firm put several of his clients into a ponzi scheme. The people to whom I’m talking had nothing to do with it, but you know the old saying about one bad apple. What is amazing is that the bad apple also was the biggest producer in that firm. The nicest, most honest guy in the firm? You are correct, he was the smallest producer.
People make financial decisions for all the wrong reasons. One of our biggest competitors in Atlanta begins every sales pitch by telling prospective clients who their biggest client is, and he is a famous, very successful businessman. Of course, no one should ever make an investment decision based on what someone else has done, but it happens all the time. An important side note here: Iron Capital considers our private clients private, and not only because selectively disclosing client names is against SEC regulations, but also because it also goes against the trust our clients have placed in us.
Investors should look for an adviser based on several important criteria:
• Background – have they ever managed money? The vast majority have not.
• The structure of their business – true independence and a fiduciary relationship.
• Their investment philosophy – does it match yours?
• Their track record of success across all of their clients, not just one star client.
Investors also should pay attention to the total cost of their portfolio. Based on what we have seen in competition, Iron Capital’s total cost is much less than anyone else we have encountered. This is not because we desire to be a low-cost leader or some kind of discount operation. Exactly the opposite is true; our service is greatly differentiated. Our cost structure is this way because our goal has never been to impress, or to gather the most assets, or to make more money than our overpaid competitors. Our goal always has been to deliver the best investment results, and if that is your goal, you try to keep investment costs to a minimum.
Some days I feel ashamed of our industry. Mr. Trott’s findings were bad enough, but to react by saying advisers should just go along and raise their fees because they can, taking advantage of irrational consumer behavior, is truly disappointing. I have a better suggestion: Let’s try to educate the consumer, not take advantage of them.
Chuck Osborne, CFA
~Irrational Investor Behavior
First and foremost let me say that our thoughts and prayers are with the people of Japan who continue to suffer in this awful tragedy. I know I have shared this story with many of you before, but any time my job forces me to focus on what is often the cold, hard reality of looking after our clients’ money during times that reminds us there are far more important things, it brings me back to those days after 9/11. I was with Invesco and I had to call fund families in New York with whom we did business to find out first, if they were alive, and second, whether they would be able to do business when the markets re-opened. It was not fun, but it was necessary. Even at times like this we have to remember that our first responsibility is to you, our clients.
So, let me cut to the chase: we had practically no exposure to Japan in any of our clients’ portfolios. We have had a sizable underweight to developed international, which is basically Japan and Europe, and within that space we had an underweight to Japan.
Having said that, we are not surprised to see the overall market react negatively to what is happening in Japan. We are also not concerned at the moment. There is a great scene in Disney’s “Pirates of the Caribbean,” when young Will Turner asks Mr. Gibbs about the story of Capitan Jack Sparrow. Mr. Gibbs talks about Jack being left behind on a deserted island and Will asserts that this must be the reason for Jack’s odd behavior. Mr. Gibbs responds, “Reason’s got nothing to do with it.”
There is a lot of investing wisdom there. Natural disasters often bring about market sell-offs and there is seldom an actual good reason for it. Business in Japan has certainly been disrupted, but the disruption is temporary. It is possible that insurance companies may be hurt with large claims, although JP Morgan this week in a letter to clients estimates that the losses will be handled easily. It is probable that Japan may need to import more coal until they can get their nuclear power plants operating safely again, but this is a temporary blip.
The truth is that Japan was an economic mess before this happened. They are still suffering from a deflationary spiral that has been going on sporadically for nearly three decades now. They are a net exporter to the world and consume relatively little, so the business disruption for US companies is not likely to be great. Even the largest Japanese companies like Toyota now manufacture in multiple locations including the US. Once the dust settles and they have the nuclear issues locked down, a rebuilding process will begin. That process actually will be stimulative to their economy.
In the meantime this tragedy occurs on the tail end of a strong six-plus month run for the stock market. Traders have been warning for a pullback but it just hasn’t happened. Is Japan a good reason for the market to fall? Well as Mr. Gibbs knows, “reason’s got nothing do with it.” Excuse, maybe; reason, no. Ultimately financial markets are about two things, prices and earnings. It is hard to see any real earnings disruption for non-Japanese companies, so any price reduction will just makes the market that much more attractive.
Of course we will be diligent should something change, but it looks like the market is progressing as we thought it would in 2011, three steps forward and two steps back.
Chuck Osborne, CFA
~Japan, Natural Disasters and the Stock Market
This may come as a surprise to some of our clients, but Iron Capital does not have a monopoly on economic or market insight (wink, wink). There are a lot of very smart people in our industry, and Wednesday night we had the honor of hearing from two of them. So I thought we would share what others think for a change.
The occasion Wednesday evening was the CFA Society of Atlanta’s Seventh Annual Forecasting Dinner, sponsored by Iron Capital, BlackRock, Morningstar, Bloomberg, Factset, and Liquidnet. Our speakers were Bob Doll and Brian Singer.
Doll is BlackRock’s chief equity strategist for fundamental equities. His group was formerly Merrill Lynch Investment Managers before Merrill sold their investment management arm to BlackRock in 2006. Doll is an optimist. He has entitled the theme for 2011, “Muddle Through and Grind Higher Plus.” ‘Muddle through’ refers to the economy, which he expects to grow but not without issues. ‘Grind higher’ refers to the market, which he believes will be up in the low double digit return range by year end. The ‘plus’ is his opinion that the risk to his forecast is that he is being too conservative.
One of his more interesting insights, and a major factor in his optimism, is that the average man on the street knows all about the problems facing our government and what bad shape the government is in. This is a cause of much concern and why most people remain negative. However, that same person has no knowledge of how strong corporate America’s balance sheet is and what good shape it is in. Markets are ultimately driven by what is happening to the companies whose shares are being bought and sold, and those companies look good.
In fact, Doll is not only optimistic, but also believes U.S. equities will lead the way. His view is that the U.S. economy will grow twice as fast as any other developed world economy, and while absolute growth still will be faster in the emerging world, the rate of growth will be declining. The U.S. will have positive trajectory while emerging-market countries will have negative trajectory.
He also likes stocks over bonds. His group likes to track the earnings yield on stocks vs. the yield on average-quality corporate bonds. These yields usually track together, but they separated dramatically last year as the yields on bonds dropped. He claims that historically this gap is always filled and the way that happens is most likely that the prices of stocks go up – reducing yield – and the prices of bonds go down – increasing yield.
Brian Singer now has his own firm, but he was previously the chief investment officer for UBS Global Asset Management. Singer is not quite as optimistic. He agrees with much of Doll’s fundamental analysis but thinks 2011 may be one of those years where fundamentals don’t really matter. He sees a clash between positive fundamentals and negative attitudes and thinks the attitude may win out. Interestingly, he said that economic activity was over-stated in the last half of 2010 because people were doing things in 2010 that they would have put off until 2011 but they were worried about changing tax rates and rules. Therefore he thinks 2011 earnings will be softer than most expect. (If you don’t completely follow that argument you are not alone; neither do we.)
Singer also made the point that China is shifting from the world’s cheap manufacturer to a more consumer-based economy. We had discussed that trend in one of our Capital Market Reviews last year, so it is not new to us. What was new is that he believes China is destined to fall apart because of social unrest. Not in 2011, he says, but he thinks in the next 30 years or so, the conflict between free market consumerism and communist rule will come to a head and the result may be China splitting into multiple smaller countries. We found this interesting as we had not heard this exact scenario before.
Both men agreed it will be a bad time for bond investors, especially government bond investors. Both agreed that structural unemployment may be higher in the future than it was in the past, and both agreed that policy makers do not really know what to do about that. They said, as most people now know, 40% or more of the earnings for the S&P 500 companies now come from overseas. What many don’t know is that 70% of the incremental earnings now come from overseas, meaning more than two thirds of the growth in U.S. companies is now coming from outside the U.S. We are truly in a global economy.
We sent you our 2011 forecast last week, so you know by now we are more in line with Doll than Singer. Still, it is important and always interesting to gather the insights of other leading professionals. I hope you found it valuable as well.
Chuck Osborne, CFA
~An Evening of Insights from Bob Doll & Brian Singer
Originally I cited another piece of my anatomy, but this is a family newsletter. The bizarre weather week we had in Atlanta has finally come to an end, and everything is back to normal. The streets are clear, mail is running, and even the Falcons resumed normalcy and will be watching the remainder of the NFL playoffs from the comfort of home as usual.
Investing is often described as being part science and part art, but in reality it is part finance – which may or may not be science, and part psychology – which may or may not be art. The wonders of human psychology were all around us here in Atlanta last week, and I think much can be learned from what we witnessed that can benefit our never-ending search for investing wisdom.
First, for the majority of you who are not in Atlanta, let me attempt to set the stage for you. It does not snow often in Atlanta, but when it does, it is always much worse than when it snows in more northern places. I have spent the vast majority of my life in the South, but I did spend four years in northern Indiana, and what I remember about those winters is as follows: it would snow and be very cold until it warmed up and the snow went away. That does not occur in Atlanta. Here, it snows, warms up, then gets cold and freezes the half-melted snow, creating ice. Once that happens it really doesn’t matter what kind of tires you have or how many of your wheels are attached to the drive train, or for that matter the years of experience one has driving on snow before moving south. The entire city shuts down, paralyzed by ice, US Postal Service included.
Fortunately in Atlanta this happens only once every few years and usually lasts one, maybe two days, before our winter temperatures are back up in the 50’s. Except this year. People were stuck for an entire week, and they did not like it. This is where human nature comes into play. Every night the local news was interviewing local residents, many of whom have moved to Atlanta from Boston, New York, Chicago, and other frequently snowy regions, and every night the people were saying the same thing: Where are all the snow plows and ice trucks? Why is the City of Atlanta not prepared for this? They should have more snow removal equipment!
Herein lies the lesson for investing. One of my mentors used to pound into my head that you manage to the norm, not the exception. That sounds so simple, but it really goes against human nature. When we are stuck in our homes and our driveways and streets are solid ice, we want to know why the city doesn’t have enough snow plows. (Zambonies probably would have been more helpful, but the people cried for snow plows.)
I have lived in Atlanta for 19 years and nothing like what happened last week has ever happened. One of my neighbors, a retired minister who has lived here her entire life, recalls a similar storm in 1973. It would be foolish for the city of Atlanta to invest in a fleet of snow removal equipment to rival cities like Boston or Chicago when something like this happens only every few decades.
We should certainly be prepared for such rare but devastating events (and for the record there are reasonable things Atlanta could have done better in response to this storm), but we must remember that such events are the exception. This is surprisingly hard; humans seem wired to believe that what is happening now is what is going to happen for the rest of eternity.
In the investing world this mentality consistently leads to projections that are either overly pessimistic or overly optimistic. Today we see pundits talking about double-dip recessions and deflation one minute, and three positive data points later the same pundits are talking about rapid growth and the threat of inflation. Reality lies somewhere in between.
This leads us to our projection for 2011: We think the S&P 500 will be up 10% in 2011, a little worse than 2010 but still solid. We think it will continue to be a rough ride, three steps forward and two steps back, as much of the global economic uncertainty of 2010 remains. We believe large caps will outperform small caps and international will continue to lag.
We are very concerned about bonds, and expect negative returns in treasuries as interest rates rise. The big unknown for 2011 is how fast and how far interest rates will go up. The biggest risk to our equity market projection would be rates rising much faster than expected, which would spook the markets.
Many will think we are foolish to believe that large-cap US equities are the place to be after they have gone nowhere over the last ten years. But then again, there are a lot of people who think Atlanta needs a big fleet of snow plows. We’ll stick to managing to the norm, and the norm says it is usually warm in Atlanta and that putting money in equities after a ten-year secular bear market is usually a very profitable thing to do.
Chuck Osborne, CFA
~Neither Rain, nor Snow, nor Sleet…My Foot!
Clients and friends,
The Blizzard of 2011 has wreaked havoc on the city of Atlanta, particularly with ice-covered streets. Schools and business are closed again today with Georgia under a state of emergency, and most of the Iron Capital staff is unable to get into our office safely. Fortunately all personnel are fully capable of working remotely. We are monitoring voice mail and email remotely and will respond promptly to all service requests. Some staff, including Chuck Osborne, our managing director, is able to get into the office due to proximity. Be assured we are monitoring your portfolios, as always, and are able to make trades as necessary.
The storm has disrupted all mail and delivery services and our building is closed to the public. Unfortunately there is nothing we can do about these inconveniences. Hopefully, the sun will come out and melt the snow and ice away, but we appreciate your patience until we can return to regular working conditions.
~Winter Storm Update and Firm Working Conditions