In Case You Missed It

Wallens, JordanJordan Wallens, Regional Director, Retirement Plan Services

By now you’ve no doubt heard all about the latest dreadful returns from our nation’s stock market. The first five months of 2013 have been historically galling for most American investors. Wait, what? Am I talking about the same roaring stock market you’re talking about? Yes! And, no.

Yes, clearly the U.S. Equity market has exhibited one of its vintage thoroughbred rallies this year. But no, sadly, it turns out the average American saver largely missed it. How can this be?

Now, throughout this banner season for equities, the largest holding in the majority of Americans’ overall asset allocation has been Cash—which is earning zero. Now lest one dismiss this truth as some other generation’s problem, to be clear: this misbegotten tail-chasing ‘bet on cash’ situation pervades across ALL age groups, right through Generation Y.

It’s like we’re our own worst enemy, because when it comes to investing, most of us are.
The problem is that savers tend to move in backward-looking, frightened herds. Which is wise…if you’re the prey.

But we invest not for short-term survival. We invest to advance long-term purchasing power.

Relax, it’s not life, just money. Money you’re not even using. That and, though it takes awhile to adjust, as a species we haven’t been hunted by predators in some time. (Pray that multi-millennial ‘food chain’ rally knows no end.)

5.30.13_Wallens_InCaseYouMissedItWhen it comes to our money, we largely still don’t get it. It’s why even Warren Buffett and Bill Gates get advice. If investors were a baseball team, they would position all eight of their fielders in the spot where the previous opposing batter’s hit had landed in preparation for the new batter at the plate. Helps to explain why an Institutional fund investor captures 90%+ of the upside in a given mutual fund, while the Retail investor deprives himself via bad behavior of fully 75% of all the long-term gains suffered in the very same mutual fund.

In spite of the adage, the average investor left to his own devices will systematically buy high and sell low every time. And why? Foremost among them, we fear present losses many, many times worse than we covet future gains. This asymmetrical analytically unsound ‘loss aversion’ leads to frenzied investor behavior, which rarely works out well. Ergo, this glorious pan-rally is the worst news in awhile, for those damaged capitalist souls who needed the help the most.

5.30.13_Wallens_InCaseYouMissedIt_2Meanwhile the S&P 500 inconspicuously peels past the thousands like a freight train. Forceful, if not fast. It’s working out great for the professionals, and those who stuck to good advice, those who stuck to their plans, timetables, discipline, and personalized their benchmarks. They never left, and as you have probably observed, historically the majority of the market’s best days/quarters strike closely behind the worst. Miss those best 10 or 20 days, and you forgo a significant chunk of your long-term returns.

Fortunately, with each passing day, more and more investors succumb to longer-term logic and get back with the program—their program. Which is a good thing, as long as you orient your benchmarks around your tested personal risk tolerance and remember your time frames. Then, most important of all, stick to your plan.

Consequences Remain from Quantitative Easing

Andy RosenbergerAndrew Rosenberger, CFA, Brinker Capital

Despite the now numerous iterations of quantitative easing, the full effects of large-scale asset purchases aren’t fully understood by market participants or policy makers. After four years of experimenting in this new Petri dish, markets understand how liquidity is created, but not where that liquidity ultimately flows to. Arguably, as evidence by P/E multiple expansion, new highs on the major indices, high yield credit spread at all-time lows, and a still sluggish economy, many believe that much of this liquidity has found its way into risky assets as opposed to the broader economy.

If we take a step back for a moment, there are three potential adverse consequences from quantitative easing (QE):

  1. Future inflation
  2. Negative political and/or sovereign perceptions
  3. Asset bubbles

To date, two out of those three adverse consequences haven’t been a problem. On the inflation front, TIPS breakeven rates are range bound, precious metal prices are falling, and lagging measures of inflation via governmental statistics are tempered. Similarly, although there have been some negative headlines surrounding the risks of QE, by no means are these rumblings excessive or prohibitive to policy continuation. However, what may present an issue is the persistence of increasing asset valuations.

5.23.13_Rosenberg_QEWhile many members of the Fed believe higher asset prices create a “wealth effect”, two recent bubbles suggest that the last thing policymakers need on their plate is another asset bubble. Finding the delicate balance between boosting wealth and not creating a new bubble suggests that the Fed will ultimately need to pullback on quantitative easing should price trends continue at their current pace. Thus, in a circular reference type of thought process, I worry that the regulator to higher equity prices may ultimately be higher equity prices in and of themselves. Said a bit differently, higher asset prices has the potential to cause concern for the Fed, resulting in a tapering off of quantitative easing, ultimately translating to a pullback in equity prices. Hence, higher equity prices may ultimately be the reason that central banks have to ease off of the pedal. Thus, in a “reflexivity” sort of way, rapidly rising asset prices may be bad for assets in the back of 2013 or 2014.

In today’s market environment, the name of the investing game is investing alongside the Fed. Naturally, one can then understand why the Federal Reserve “tapering” their quantitative easing is such a big deal. When the rules of the game change, it takes time for markets to understand the paradigm shift and transition from the easy liquidity from central banks. Our belief is that the Fed is well aware that it greatly influences markets and thus will try to make this transition as smooth as possible without pushing markets into bubble territory.

Behavioral Finance 101: Irrationality

DanielCrosbyDr. Daniel Crosby, Ph.D., IncBlot Behavioral Finance

In part one of our three part series, we touched on “heuristics”, or the experiential rules of thumb that serve as decisional markers. Part two will discuss a second pillar of behavioral finance, irrationality. But before we can talk about irrationality in any meaningful way, we must define what it means to be irrational.

One of the hallmark difficulties of psychology as a science is that it requires “operationalization” of the subjective variables it hopes to measure. That is, it must provide sometimes-ethereal constructs such as happiness or rationality with a set of parameters that allow them to be measured and interpreted. When traditional economic models were constructed, they needed to account for things such as “utility” that had to be operationalized to be accounted for within the model.

Using the logic of the time, they put forth the seemingly straightforward maxim that a rational investor, homo economicus, would act to maximize utility at all times, with utility being defined as dollars and cents. Basically, economic decision makers would consistently act in such a way that their investment returns would be improved to the extent possible.

5.22.13_Crosby_Blog2This idea of rational investors working to maximize returns had two profound positives that served it well over the many years it enjoyed preeminence: 1. It had intuitive appeal 2. It was easily measured. After all, do not most of us engage in all manner of unpleasantness (e.g., staff meetings) to make a buck? And are not dollars more easily debited and credited than say, units of happiness or some other more vague notion of utility? Resting on these two foundational strengths, the idea of rational, wealth-maximizing investors persisted for decades…until the music stopped playing.

Four hundred years ago, in one of the first speculative bubbles on record, a Dutch commodity traded for 10 times the annual salary of a skilled laborer. In some cases, this commodity fetched as much as 12 acres of prime farmland and even single family dwellings.

The commodity of which I’m speaking is a single tulip bulb.

5.22.13_Crosby_BeFiBlog_2_pic2You see, it was thought that tulips were an investment that would always appreciate in value and were immune to the ups and downs of comparable tradable goods. Fast forward three hundred years to 1925 and you would have heard statements like this from the investment gurus of the day…”there is nothing that can be foreseen to prevent an unprecedented era of prosperity.” Sure there had been disastrous crashes in the past, but this time was different.

It’s comforting to think of New Era mindsets as a relic of the past, a trick of the mind that fooled investors less savvy than ourselves. But as recently as the Great Recession of the past five years and the tech bubble of the turn of the century, New Era Thinking has been more present than ever. In the wake of these most recent crises there has been a dramatic uptick in the acceptance of the fact that investors are simply not rational. Quite the contrary, we engage in a number of irrational behaviors that can thwart our best efforts at financial security. This danger is especially real inasmuch as we remain unaware of their impact.

In 1998,, an internet upstart, had sales of $30M, profits of -$28.6M and a total market capitalization of $8 billion. Toy veteran Toy’s R Us on the other hand, had more than 40 times the sales but only ¾ of the total stock value. The advent of the internet was greeted by Wall Street with great enthusiasm, such great enthusiasm that people lost their minds. The thought that the web would revolutionize the way we do business was correct, but the notion that financial fundamentals no longer mattered was not.

5.22.13_Crosby_BeFiBlog_2_pic3Another example of investor irrationality is the belief that our mere involvement with an investment will make it more profitable. A recent study found that people were willing to pay a mere $1.96 for a lottery ticket with 1 in 50 odds if they were assigned a ticket randomly. However, if they were able to choose their number from among the 50, they were willing to pay $8.67 for the ticket. The odds remained at 2%, but the participants agreed to pay over four times more if they could become personally involved. After all, they felt their involvement spelled positive change. It goes without saying that paying four times as much for something with no measurable increase in the probability of success can hardly be called rational.

I could go on, but the point here is not to erode your confidence or create a lengthy list of your imperfections. The point is to heighten your awareness of the potential for irrationality to damage you financially in ways that have a real impact on you and your loved ones. After all, you can’t correct for what you don’t acknowledge. If there is any good to come out of the trillions of dollars in capital that vanished during the bubbles of the last 13 years, it may be that we have been permanently and irrevocably humbled and have a greater sense of the limits of our own rationality. Hopefully we’ve learned our lesson. Hopefully, this time really is different.

Winds of Change

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The winds of change have begun to blow through Washington, D.C. carrying with them whispers that the Federal Reserve Bank of the United States is contemplating a more immediate slowing of the unprecedented stimulus measures it has employed since the financial crisis than many analysts anticipate, which could have broad implications across the global landscape. Several signals have been offered by the American Central Bank in the past few weeks to prepare the marketplace for the impending reduction of their involvement, highlighting the delicate nature of this endeavor.

The Institution faces a daunting challenge in trying to scale back a program that has largely been credited with fueling a dramatic rise in asset prices, without interrupting the current rally in equity markets.  Although the U.S. economy has shown itself to be growing at a moderate pace, a measure of uncertainty lingers within investors as to whether this growth is robust enough to compensate for the paring back of the Bank’s historically unprecedented accommodative monetary policies.

As the depths of the ‘Great Recession’ threatened to pull the global economy into depression, the U.S. Central Bank undertook a herculean effort to bring the country back from the precipice of disaster. The tangible result of these efforts has been a deluge of liquidity forced upon the marketplace, which has given birth to a tremendous rally in share prices of companies listed around the globe, and helped to repair much of the damage inflicted by the crisis. The dramatic expansion of the Fed’s balance sheet, since the inception of these programs, has culminated in the most recent iteration of these efforts—an open-ended program of quantitative easing, comprised of the purchase of $45 billion per month in longer dated U.S. Treasury debt and $40 billion of agency mortgage-backed securities, undertaken in September of last year, that has brought the aggregate amount of assets acquired by the Bank to more than $3 trillion.


The chart above depicts the increase in the size of the Fed’s balance sheet (white line) versus the S&P 500 Index (yellow line).

As the economic recovery has gained momentum in the United States, with notable improvements seen in both the labor and housing markets, concern has been voiced that the flood of liquidity flowing from Washington should be tapered, lest it potentially result in the creation of artificial asset bubbles, which in turn could present risks to price stability.

The first broach of the possibility of the Fed varying the additions it is making to its balance sheet came in a press release from the Federal Open Market Committee on May 1 which stated that, “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” This statement was followed by the May 11th publication of an article authored by Jon Hilsenrath of the Wall Street Journal, who is widely considered to be a de facto mouthpiece for the Central Bank, “officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated” (Wall Street Journal). Comments issued on Thursday by the President of the San Francisco Fed, John William’s, referred once again to the possibility of the Central Bank’s program being scaled back, potentially sooner than many market participants anticipate, “It’s clear that the labor market has improved since September.  We could reduce somewhat the pace of our securities purchases, perhaps as early as this summer” (Bloomberg News).

Though the Fed has stated that it will continue its accommodative monetary policies until the unemployment rate in the United States has been reduced from its current rate of 7.5% to a target of 6.5%, it appears that the pace of this accommodation may change in the near term.  While the consensus among market participants is for this gradual reduction in quantitative easing to begin sometime this year, no one is sure of the scale or the exact timing.  As the Central Bank has played such an integral role in helping to engineer the current rally in equities, it will be imperative to closely monitor the deftness with which they handle the extrication of their involvement.

Is America’s Retirement System Broken?

SimonBill Simon, Managing Director, Retirement Plan Services

In an article earlier this week, Mr. John Bogle, founder of the Vanguard Group, decreed that America’s current retirement system is broken. As far as a fix, he offers only two suggestions. The first is to increase the current level of taxable income subject to Social Security taxes to $140,000-$150,000. The second is a reduction in the automatic cost of living adjustments that are used to calculate benefits.

While both would generate significant increases and savings to Social Security, they do not address the larger issues with our retirement system. As Bogle notes, the three pillars of retirement are Social Security, Defined Benefit plans and Defined Contribution plans—and they are in bad shape. In order for defined contributions plans to work better, we need to continue to automate as much of the functionality as possible, incentivize larger contributions, and make sure that an appropriate investment option is selected based on the participants age and realistic expectations about goals and markets.

5.15.13_Simon_BogleArticleHere is some food for thought. What if you could earn an additional tax credit by deferring at least 10% of salary or not having a loan against your 401(k)? What if an employer gave one additional vacation day per year if a company-wide goal of participation and contribution was reached? Ultimately, the system can work, but we need to continue to innovate and provide fresh ideas.

Click here to read more on John Bogle’s comments.

Secrets of Professional Presenters

Bev Flaxington@BevFlaxington, The Collaborative

Unless you are growing your business by giving presentations, you might not think about the importance of learning strong presentation skills. But it’s important for financial advisors to realize that each time you speak to a client or prospect, host a seminar or educational event, or speak to your team about firm goals and objectives, you are presenting. Being able to present your ideas in an effective manner is critical to success. You might be very intelligent and even creative, but if you cannot communicate in a manner that “wins over” your audience, you might be missing opportunities.

What makes the difference between a good presentation and a poorly delivered one? Often times it is the material; either we like what we hear or we don’t. Often times it is the presenter – if they are engaging and interesting, we pay more attention. Whether your next presentation is sitting one-on-one with a client, presenting to a board for a not-for-profit client, or standing in front of a roomful of people you’d like to gain as clients, the following six secrets from professional presenters may help:

  1. Establish what you want to accomplish at the outset. Is your presentation meant to persuade or to inform? Are you hoping to gain a client’s agreement on something or just wanting to tell your staff about a new change that’s happening? Always think about why you are doing the presentation and what the desired outcome is before you put together your material.
  2. What does the listener want from you? What are their goals in the exchange? Learn as much as you can about your listener or group. In a meeting with several people, ask them to raise their hands to questions about the material: How much do they know already? What prior experiences have they had? What do they hope to learn? In a one-to-one, get the other person talking. What do they hope to accomplish? The more you can engage and learn about your audience, the more engaged they will be with you.
  3. Put your information into a segmented format so that your audience can follow along with you. If, for example, you are presenting on the first-quarter market activity, you might segment: (a) Last year’s first quarter, (b) This year’s performance, (c) Changes from one year to the next and the meaning, Impact on you as the investor, and (e) Next steps you as the investor want to take in your portfolio. You want to take your material and put it into chunked segments so the audience knows where you are, and what you are talking about, at all times.
  4. Don’t assume the audience knows what you mean and why the material is relevant to them. It’s critical to provide context. Help the listener understand why they should care – the “so what?” and relevancy for their lives. If you are simply offering information, that’s fine, but let the audience know. When hoping to persuade a listener or set of listeners, it is absolutely critical to make the connection and allow them a clear window into the “why?” of the information to their needs and their lives.
  5. 5.13.13_Flaxington_Secrets of Professional PresentersCheck for understanding. Watch body language as you speak. Are people staying engaged? Are they nodding or shaking their heads? Are they focused on you? You want to make eye contact, smile and be engaged, and you want to watch the listener, too. Find ways to put questions in, or ask the audience to raise their hands. Work on engagement throughout your presentation and ask for questions to allow for deeper understanding.
  6. Have a clear next step. What do you want the audience or listener to do as a result of your presentation? Be clear what you want the listener to do. If you stated a desired outcome at the beginning of the dialogue, refer back to it now. And if you can get the listener to commit to a next step, have them do so in writing or to you verbally. A public commitment is always best.

Find ways to work on your presentation skills, and incorporate some of these ideas the next time you have an opportunity to present.

Behavioral Finance 101: Heuristics

DanielCrosbyDr. Daniel Crosby, Ph.D., IncBlot Behavioral Finance

While the field of behavioral finance has been around for 40 or so years (depending on who you ask), it truly came into its own in 2002 when Daniel Kahneman received the Nobel Memorial Prize in Economics for his work around uncertainty and decision-making. Although he claims never to have taken an economics class, Kahneman’s work shed new light on the ways in which actual people behave under real-life circumstances, as opposed to the idealized assumptions of efficient market hypothesis, the theretofore ascendant paradigm for understanding investment outcomes.

While one of the nagging critiques of behavioral finance is that it has no mutually-agreed-upon philosophical framework, most psychologists divide it into three pillars: heuristics, irrational behavior and framing. Over the next few weeks, we’ll take each of those three pillars and try and understand them a little more deeply. In so doing, we’ll also tackle the “so what” of behavioral finance for the average investor. Without any further adieu I give you Part One of our survey course on behavioral finance – Heuristics.

I’m not sure what time of day you’re reading this, but whenever it is I can be sure of one thing: you’ve already made a lot of decisions today. First of all, there was whether or not to hit the snooze button. Then, what to have for breakfast? Luffa with body wash or bar soap in the shower? Grey suit or navy suit? And so on and so forth. The point is, given the myriad decisions we all face every day, it’s no wonder that we end up relying on heuristics or experiential rules of thumb, when making even important decisions. To give you a little firsthand experience with heuristics, I’d like to ask you to do the following:

5.9.13_Crosby_BeFiBlog_1Quick! Name all the words you can that begin with the letter “K.” Go on, I’m not listening. (Insert Jeopardy theme song here). How many were you able to come up with? Now, name all of the words you can in which K is the third letter. How many could you name this time?

If you are like most people, you found it easier to generate a list of words that begin with K; the words probably came to you more quickly and were more plentiful in number. But, did you know that there are three times as many words in which K is the third letter than there are that start with K? If that’s the case, why is it so much easier to create a list of words that start with K?

5.9.13_Crosby_BeFiBlog_1_pic3It turns out that our mind’s retrieval process is far from perfect, and a number of biases play into our ability to retrieve data with which we’ll make a decision. Psychologists call this fallibility in your memory retrieval mechanism the “availability heuristic,” which simply means that we predict the likelihood of an event based on things we can easily call to mind. Unfortunately for us, the imperfections of the availability heuristic are hard at work as we attempt to gauge the riskiness of different decisions, including how to allocate our assets.

In addition to having a memory better suited to recall things at the beginning and the end of a list, we are also better able to envision things that are scary. I know this first hand. Roughly six years ago, I moved to the North Shore of Hawaii along with my wife for a six-month internship. Although our lodging was humble, we were thrilled to be together in paradise and eager to immerse ourselves in the local culture and all the natural beauty it had to offer. That is, until I watched “Shark Week.”

5.9.13_Crosby_BeFiBlog_1_pic5For the uninitiated, “Shark Week” is the Discovery Channel’s seven-day documentary programming binge featuring all things finned and scary. A typical program begins by detailing sharks’ predatory powers, refined over eons of evolution, as they are brought to bear on the lives of some unlucky surfers. As the show nears its end, the narrator typically makes the requisite plea for appreciating these noble beasts, a message that has inevitably been over-ridden by the previous 60 minutes of fear mongering.

For one week straight, I sat transfixed by the accounts of one-legged surfers undeterred by their ill fortune (“Gotta get back on the board, dude”) and waders who had narrowly escaped with their lives. Heretofore an excellent swimmer and ocean lover, I resolved at the end of that week that I would not set foot in Hawaiian waters. And indeed I did not. So traumatized was I by the availability of bad news that I found myself unable to muster the courage to snorkel, dive or do any of the other activities I had so looked forward to just a week ago.

In reality, the chance of a shark attacking me was virtually nonexistent. The odds of me getting away with murder (about 1 in 2), being made a Saint (about 1 in 20 million) and having my pajamas catch fire (about 1 in 30 million), were all exponentially greater than me being bitten by a shark (about 1 in 300 million). My perception of risk was warped wildly by my choice to watch a program that played on human fear for ratings and my actions played out accordingly. This, my friends, is heuristic decision making hard at work.

Hopefully by now the application to investment decision-making is becoming apparent. For so long, we have been sold an economic model that posited that we had perfect, uniform access to information and made decisions that weighed that information objectively. In reality, our storage and retrieval processes are imperfect, with recent and emotionally charged pieces of data looming larger than the rest.

5.9.13_Crosby_BeFiBlog_1_pic4Investors and financial services professionals that understand these imperfections are better positioned to understand the limitations of their knowledge and try to intervene accordingly. At times this may mean taking a more tentative position to circumvent undue risk. Other times this may mean digging a little deeper on what may initially appear to be a foolproof trade. Whatever the case, it is only after we free ourselves from the myth of homo-economicus, that we are able truly become our best investing selves. Making decisions based on subjective logic needn’t be your undoing as an investor, but assuming that you’re a perfectly logical decision maker just might.

Monthly Market and Economic Outlook – May 2013

Magnotta@AmyMagnotta, CFA, Brinker Capital

Risk assets continued their run in April, despite a small 3% pull-back mid-month. The easy monetary policies pursued by central banks in developed economies have forced investors out of cash and into higher yielding fixed income and equity strategies.  On May 3 the S&P 500 pushed above 1600 to an all-time high.  International equity markets outperformed U.S. equity markets in April, helped by continued strong performance from the Japanese equity markets, but U.S. markets continue to lead year to date. Even with stronger equity markets, the fixed income markets also rallied in April as interest rates moved lower and credit spreads tightened further.

After a near 20% move in the U.S. equity markets since November of last year, we may be susceptible to a pull-back in the near term; however, our longer-term view remains constructive. The market remains in a stronger fundamental position that at the 2007 high.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move through the second quarter. A number of factors should continue to support the economy and markets for the remainder of the year:

  • 5.6.13_Magnotta_MonthlyNewsletter_3Global Monetary Policy Accommodation: The Fed continues with their quantitative easing program, the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. The markets remain awash in liquidity.
  • Housing Market Improvement: Home prices are increasing, helped by tight supply. Sales activity is picking up, and affordability remains at high levels. An improvement in housing, typically a consumer’s largest asset, is a boost to consumer confidence.
  • U.S. Companies Remain in Solid Shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Borrowing costs remain very low. Corporate profits remain at high levels and margins have been resilient.
  • Equity Fund Flows Turn Positive: After experiencing years of significant outflows, investors have begun to reallocate to equity mutual funds. Positive flows could provide a tailwind to the global equity markets.

However, major risks facing the economy and markets remain, including:

  • 5.6.13_Magnotta_MonthlyNewsletter_2Europe: The ECB programs have bought time, but cannot solve the underlying problems in Europe. Austerity measures are serving only to weaken growth further and cause higher unemployment and social unrest. After how it dealt with Cyprus, there is risk of policy error in Europe once again.
  • U.S. Fiscal Policy: The automatic spending cuts will start to negatively impact growth in the second quarter, shaving an estimated 0.5% from GDP. In addition, the debt ceiling will need to be addressed again later this year.

Because of massive government intervention in the global financial markets, we will continue to be susceptible to event risk. Instead of taking a strong position on the direction of the markets, we continue to seek high conviction opportunities and strategies within asset classes. Some areas of opportunity currently include:

  • Domestic Equity: dividend growers, housing-related plays
  • International Equity: Japan, small and micro-cap emerging markets, frontier markets
  • Fixed Income: non-Agency mortgage backed securities, corporate credit, short duration strategies
  • Real Assets: REIT Preferreds, Master Limited Partnerships
  • Absolute Return: relative value, long/short credit
  • Private Equity: company specific opportunities
Annualized for periods greater than one year. Past performance is no guarantee of future results. Source: FactSet, Red Rocks Capital.

Annualized for periods greater than one year. Past performance is no guarantee of future results. Source: FactSet, Red Rocks Capital.




The views expressed by Brinker Capital are for informational purposes only. Brinker Capital, Inc. a Registered Investment Advisor.

Reading The Fine Print – Part Two

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

In part one of my blog post, I discussed how important it is to read the fine print when selecting the right managers. “Things are not always what they seem, and by doing a little bit of digging, you can unearth some red flags that hopefully help you make a more educated decision, or at least ask the right questions.”

I left you with three warning signs of sorts that I’ve run into throughout my years of selecting investment managers:

  • Backtested numbers
    When you take a particular portfolio, or a process, and ask, “How would this have performed over a certain time period?”—that’s backtesting. There’s merit in doing this, but you really have to be careful on the value you place on the data. Anyone can build a portfolio that looks great using backtested data. If it’s a portfolio of mutual funds, just pick the ones that did the best. If it’s a quantitative model or a tactical model, just pick the algorithm that worked the best. You’ll never see a backtested quantitative or tactical model that doesn’t have a good outcome in recent markets.Not surprisingly, I have yet to come across a quantitative or tactical portfolio that has performed in actuality as well as it performed in backtesting. A backtest is good for telling you how the strategy would perform in various markets to help develop your expectation levels, but should not be used to decide if the strategy adds value.
  • Seed Accounts
    4.26.13_Raupp_FinePrint_2Firms will often start seed or model accounts to get a track record of performance started. These typically have little or no client assets and are often funded entirely by firm assets. While the firm can make the claim that they’ve been running money that way for a number of years, the reality was that their clients didn’t experience the front end of that.There are a few risks in play here. The firm could have run multiple seed accounts, discarding the ones that didn’t work and promoting the one that did. The objective itself or the universe of eligible securities may have changed before the strategy was offered to clients. As with backtested numbers, there is value in looking at seed performance, but if the backbone of a strategy’s pitch is great performance in 2008 and there were minimal assets that benefited, you have to ask, “Why?” Would the firm make the same decisions with billions of client assets that they did with $100,000 of seed capital?
  • Merged Track Records
    When firms combine, or merge products, often from multiple track records comes one track record. Ideally, the track record from the product that was most reflective of the surviving product would be used, but, more likely, the best track record will be the one that wins out. Knowing whether the track record is reflective of the current team, process and philosophy is vital.

Whenever you look at the performance of an investment strategy, you should always give careful consideration of exactly what you’re looking at. Reading through the disclosure is a necessity, as is asking questions about things that are unclear. The fine print can often help you make more educated decisions of where to invest.

Hang Your Hat on This: Watermark Consulting’s Consumer Experience ROI Study

Sue Bergin@SueBergin

Lacking a crystal ball, many investors, advisors, analysts and researchers look for something dependable that may aid in their ability to predict stock performance.  The trends and studies sought out can range from analyzing relationships between the countries of origin of Sports Illustrated swimsuit models, Super Bowl Champion football teams, and Boston snow accumulations and the stock market.[1]

For a more enlightening stock market predictor, however, turn to Watermark Consulting’s 2013 Consumer Experience ROI Study.

Watermark’s research shows a substantial performance gulf between companies who deliver a positive customer experience and those that do not.

Using model portfolios of the Top 10 (Leaders) and Bottom 10 (Laggards) publicly traded companies in Forrester Research’s annual Customer Experience Index ranking, Watermark has demonstrated a compelling link between consumer experience and stock price.

Over a six-year period, customer experience leaders outperformed the broader market, generating a total return three times higher on average than the S&P 500.  By contrast, the Laggards trailed the S&P 500 by a wide margin.

As Watermark Founder Jon Picoult points out, the analysis reflects over half a decade of performance results spanning an entire economic cycle, from the pre-recession market peak in 2007 to the post-recession recovery that continues today.

Customer Experience Leaders Outperform the MarketWhile it’s important not to make investment decisions based solely off of one dataset, Watermark’s study is one that you can hang your proverbial hat on when considering investments in people or processes that enhance your clients’ experience.

[1] MSNBC’s 11 Most Shocking Stock Indexes.