Thursday, July 14, 2016

Observations And Questions


Hi Scott,

Just listened to this week's webinar - I do appreciate the work that goes into every Tuesday - thanks.

I do have an observation and a few questions to share / ask . . .

First, an observation . . .

The fact that all the central banks are still in a loosening and easy credit world seven years after the financial crisis is troubling.

There is no historical precedent for what we are seeing. As a result, the financial trends that we have become accustomed to for the past 3 to 5 years are changing in a significant way - the 60 / 40 model performance for the past three to five year will not be easily matched with strengthening deflationary pressures.

It's my assumption that you are subtle trying through blog postings to prepare clients for this realization - though I find the 3 to 5 year performance reference within the webinar(s) counters the messaging.

Questions

It's my impression that a 60 / 40 model provided satisfactory returns during normal economic environment (past 3 decades) - it may not be well suited for our present historical precedent.

1) The corporations domiciled in the US (50% portfolio) + (26% other (international)) . . . all these boats have risen in the past with significant central bank liquidity. A great many may not under deflationary pressures, e.g. financials. Is the equity ETF component heavily weighed in financials?

2) Regarding the bond ETF, what type of bonds are within the model portfolio?

3) NIRP (negative) interest rates is an attempt by central banks to monetize deflationary debt - soon they maybe forced to unleash helicopter money, hence inflation. Is the High Rock tactical strategy flexible and robust enough to counter these opposing financial environments as they unfold in the future with non-correlated alternative investments?

I welcome your thoughts and comments.

Kind regards,


As always, excellent questions, Thank you!

We are certainly in uncharted territory and record low (or close to) bond yields tell us that, at least for the time being, safety is in demand.

In the meantime, equity markets are more like a casino  every day (and I loathe gambling). The very low risk-free rate of return, as a result of central bank stimulus, drives those who desire to get a higher rate of return into riskier and riskier assets.

But that is today and could possibly last until the next recession re-adjusts the way investors are currently thinking. Behavioral Finance experts suggest that one of the human emotional "errors" (of investing) is to project the current circumstances out into the future indefinitely (termed: Recency Bias). In actual fact, economic periods cycle: low growth, low inflation into higher growth and higher inflation and back again, although the time frames for this may vary.

Long-term rates of return will also cycle.

So we must accept that, in time, the average rates of return will move higher and lower (above and below average) as well.

But we must also always remember the fact that historic returns are in no way a guarantee of future returns.

There was a time in 2010-2013 when investors wanted a greater risk-premium for owning equities (and they were relatively cheap in terms of earnings per share). 2014 to now has seen that risk-premium evaporate and earnings per share metrics take a back-seat to the gambling mentality (with the desire for more "immediate gratification"). As we evolve through the cycle, this too will change, but again, the timing is not necessarily predictable (although we do try to give it our best "guesstimate").

ACWI

XBB

For more detailed information on these "benchmarks" please check the links for the fact sheets that should give you all the information that you are looking for.

Remember that (for us) these are just performance gages (and by no means a recommendation for purchasing them). In other words, if you just bought these index ETF's in your portfolio and (avoided paying us our fee) you would get the advertised return (less the small MER).

So our job (as portfolio managers) is, over time, to give you a better return than you might get by just owning the ETF's.

That is why we like to show them, so that clients can make a determination as to whether we are doing our job as far as returns are concerned. (It is not necessarily always about return, so clients must also put a value on the qualitative aspects of what we do as well).

I remember a discussion with the president of the bank firm who had recently taken over the independent firm that I had been with (we had always had performance on the on-line, client facing, portfolio reporting site, the bank did not) whereby he told me that most IA's (Investment Advisors) at the bank didn't want clients to see their performance. Really? Now why would that be?

Interestingly, the new rules are forcing the reporting of performance and the fees that those advisors take. So clients can make the determination with more information. I would suggest that this transparency will bring about some movement of clients who will now realize that they are not getting what they paid for.

We will welcome them with open arms (and total transparency).

Finally, as you suggest, inflation will return (and the cycle will progress) and there may be a period of time when traditional asset classes do not offer the historic average returns. This is why we have added a third dimension to our offering. The "tactical" (value / opportunity) model. We want to be able to add value when the traditional 60/40 portfolio mix is not giving us the growth that we desire (and yes it could very well hold "non-correlated" assets, if, in our judgment, that is a sensible approach to enhancing risk-adjusted returns.

I hope that this helps and as always, we are more than happy to discuss this in greater detail if you wish.

Warmest regards,

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