Private Equity : Diversify Your Wealth

As an independent business owner who has put years of hard work into your successful enterprise, it is pretty important to take stock and have a good look at your Diversification Risk.

How much is your business worth and how much of your wealth is tied up in it?

In many cases owners are so focused on their business that they do not get an opportunity to step back and look at their over-all financial picture.

In some cases owners are not even sure what their business is worth.

From a planning perspective, this becomes difficult, because at some point you are going to need an idea of your net worth and exactly how you will strategically create an income stream for yourself (and your family) in your next stage of life: post ownership (we used to call it retirement!!)

"Succession planning is all about taking the helm and setting the course for your eventual exit from the business...Failure to plan, communicate, and manage succession is the greatest threat to the survival of a business" (Succession Planning Toolkit for Business Owners, Weigl et al).

Even if the next stage (of life) is years away, there may be a significant amount of risk in having most of your wealth tied up in one asset: your business.

In her book Money Magnet: How To Attract Investors To Your Business, Jacoline Loewen discusses some very interesting ideas for not only taking some of your hard-earned wealth out of your business, but also getting a capital injection at the same time so that you can continue to maximize its growth potential.

Diversification (to make your wealth manager happy) and the ability to continue to grow your business, sounds like getting your cake and eating it too!

How? Private Equity , or as Jacoline so eloquently puts it : "O.P.M. (other peoples money)".

"Money Magnet is a guide for entrepreneurs interested in accessing capital from the private equity market. It is addressed to entrepreneurs, in accessible language, by an author who has spent a career helping businesses grow.
Undoubtedly, owners and founders of businesses need capital, but too often a trip to the dentist seems more appealing than dealing with financing."

http://www.moneymagnetbook.ca/

Succession planning and Private Equity can work hand in hand to help business owners diversify and strategically plan their (and their families) future.

It only makes sense to click on the above link and delve a little further into this great option. Can I help? Contact me to explore the possibilities!

The Educated Investor and the Psychology of Investing

Professor Meir Statman is the Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University, Santa Clara, Calif.,

Taken from :
The Monitor, The Voice of the Investment Management Consultants Association,
May / June 2005: What is Behavioral Finance, The Monitor, 2005.Cognitive Biases Series: a collection of articles from IMCA's publication, The Monitor.

"I describe financial advisers as financial physicians. Good physicians promote both health and well-being, and good financial advisers promote both wealth and well-being. Good physicians ask, listen, and empathize with their patients; they diagnose what’s wrong; they educate; and, finally, they treat. Good physicians must possess all the relevant knowledge and tools of medicine, and they must also have the handholding and educational abilities of good psychologists. Good physicians must play psychologist because body and mind are not separate.

The same is true for financial advisers. Some financial advisers prefer to keep away from the wellbeing issues of their clients; they only want to find good money managers and calculate accurate alphas. I say to them what I would say to a physician who prefers not to deal with patients: be a pathologist.Confine yourself to a back room where you can choose money managers and evaluate their performance. Let someone else help live human investors."

So for all you "live, human investors"...many of you clients, some thinking about being clients and others perhaps looking for someone who really does care about you.......

In light of the current Investment environment, I have tried to find a good synopsis on Behavioral Finance theory, which can explain the thought process and research behind broadly diversified, less actively- managed portfolios. It is a bit long and a little technical, but I think it underscores what is important. The highlights (bold) are mine. I plan to build on this theme with a "webinar" ( a conference call seminar with live internet feed to your computer) shortly.

Psychology is the basis for human desires, goals, and motivations. Psychology is also the basis for a wide variety of human errors that stem from perceptual illusions, overconfidence, over-reliance on rules of thumb, and emotions.

Errors and bias cut across the entire financial landscape, affecting individual investors, institutional investors, analysts, strategists, brokers, portfolio managers, options traders, currency traders, futures traders, plan sponsors, financial executives, and financial commentators in the media.

Successful investing requires taking the psychological propensities of others into account.

Statistics and probability are essential concepts when it comes to risk. Yet, most people have poor intuition about statistics and probabilities. Instead of behaving like professional statisticians, they rely on flawed intuition, based on rules of thumb called heuristics. By using heuristics people render themselves vulnerable to errors and biases. That is why the first theme of behavioral finance is called heuristic-driven bias.

A frame is a description. Frame dependence means that people make decisions that are influenced by the manner in which the information is presented. Frame dependence manifests itself in the way that people form attitudes towards gains and losses. Many people make one decision if a problem is framed in terms of losses, but behave differently if the same problem is framed in terms of gains. An important reason for this behavior is loss aversion. Hedonic editing is the practice of choosing frames that are attractive relative to other frames. People with self-control problems often use hedonic editing to help them deal with those problems.

Markets are efficient when prices coincide with intrinsic value. Heuristic-driven bias and frame dependence combine to render markets inefficient. Representativeness leads to the winner–loser effect, whereby investor overreaction causes prior long-term winners to become future long-term losers, and prior long-term losers to become future short-term winners. Conservatism leads security analysts to underreact to earnings surprises, thereby generating short-term momentum in stock prices. Frame dependence leads investors to frame stock returns in terms of short horizons instead of long horizons. As a result, investors require a larger equity premium than they would if they framed returns using longer horizons. Prices can deviate from fundamental value for long periods, with excess volatility the result.

Wall Street strategists are susceptible to gambler's fallacy. In general, four important behavioral elements affect the market predictions of investors: overconfidence, betting on trends, anchoring and adjustment, and salience. Although gambler's fallacy generally afflicts Wall Street strategists, it typically does not afflict individual investors and technical analysts—they succumb to other errors. This point leads to a discussion about some of the key illusions that most people have about randomness, and why these illusions bias their predictions. Inflation adds an additional element of confusion.

Many investors believe they can make money by betting against the market predictions contained in advisory newsletters. Yet, they are wrong. Investors are wrong about advisory newsletters, and they hold fast to mistaken beliefs. And the issue goes beyond the predictions of newsletter writers. The general question is why people hold views that fly in the face of empirical evidence. The general explanation centers on overconfidence, overconfidence that stems from the tendency to overlook disconfirming evidence. Consequently, overconfident investors come to hold invalid beliefs. They succumb to what psychologists Robin Hogarth and the late Hillel Einhorn call the illusion of validity.


The third theme of behavioral finance is inefficient markets. In recent years scholars have produced considerable evidence that heuristic-driven bias and frame dependence cause markets to be inefficient. Scholars use the term “anomalies” to describe specific market inefficiencies. For this reason, Eugene Fama characterizes behavioral finance as “anomalies dredging.” Market efficiency is a direct challenge to active money managers, because it implies that trying to beat the market is a waste of time. Why? Because no security is mispriced in an efficient market, at least relative to information that is publicly available. Inside information may be another story.

Placing funds with an active money manager is typically a bad bet. Yet, institutions continue to hire active money managers. Why? The short answer is that the individuals who serve on institutional investment committees exhibit frame dependence and heuristic-driven bias. When it comes to framing, committee members tend to think of portfolios as a series of mental accounts, with associated reference points known as benchmarks. Therefore, they tend to mistake variety in manager “styles” for true diversification. In addition, reference point thinking tends to make people give opportunity costs less weight than out-of-pocket costs of the same magnitude. In addition to frame dependence, members of institutional investment committees bear responsibility for the performance of the portfolio. Consequently, they are vulnerable to regret. Choosing active managers enables committee members to shift some of the responsibility for performance onto the managers, thereby reducing their own exposure to regret. Heuristic-driven bias stems mostly from reliance on representativeness. Specifically, representativeness underlies the mistaken belief in a “hot hand,” an effect that leads sponsors to believe, mistakenly, that they have the ability to pick managers who can beat the market.

Abstracts from:
Beyond Greed and Fear
Understanding Behavioral Finance and the Psychology of Investing

Shefrin, Hersh Holds the Mario L. Belotti Chair in Finance, Leavey School of Business, Santa Clara University
Print publication date: 2002 (this edition)Published to Oxford Scholarship Online: November 2003Print ISBN-13: 978-0-19-516121-2doi:10.1093/0195161211.003.0006

If you made it through and want to discuss this further, feel free to contact me.

Next blog I'll devote to Private Equity financing and specifically, Jacoline Loewen's new book Money Magnet - Attract Investors to Your Business http://canadianprivateequity.blogspot.com/.....so stay tuned!!

The WOW Service Checklist

Here are the guidelines we use to ensure that our clients have the optimal client experience:



Investment Satisfaction:



1) Makes an exceptional effort to understand each client's unique needs.

2) Works with each client to define those needs in considerable detail.

3) Provides well thought-out and viable alternatives suited to solve those needs.

4) Investment advice is appropriate based on each client's objectives.

5) Investment performance is dependable.

6) Investment performance is good relative to the indices.

7) Portfolio performance, at a minimum, meets client expectations.



Services Satisfaction:



1) Clients are extensively involved in the decision-making process.

2) Clients needs are understood and have high priority.

3) Client privacy and confidentiality are strictly maintained.

4) Client queries are responded to on a timely basis.

5) Clients are updated on a regular basis and immediately following a major event.

6) Administrative errors should not occur (but if they do, they are quickly and efficiently dealt with).

7) All deadlines are strictly adhered to.



Relationship Satisfaction:



1) There are no "stupid" questions.

2) Client feedback is invited and used to further enhance service.

3) Stewardship is the on-going monitoring and regular contact to ensure that established goals are being met or otherwise strategy is adjusted accordingly.

4) Is this a comfortable relationship for the client?

5) Is there a feeling of Trust for the client?



Success = Results - Expectations



Is your client experience optimal?

Current Thoughts On The State Of Capital Markets

This is my current thinking (for what its worth) and what I am saying to clients who have called in the last couple of days:

1) Economic issues are front and centre in the media: increased unemployment, severe slowing of economic growth across most sectors, tight credit markets (and on and on, blah, blah....).

2) All of that is built-in to the current valuations of holdings (and in some cases, in smaller and less liquid investments, there is significant undervaluation).

3) Historically, equity markets tend to lead the economy, i.e. they usually respond / react to negative stimulus well before the economy turns down. The reverse is true on the upside (6 to 10 months ahead).

4) While most investors wait for signals in the economy to give them more confidence, more shrewd, value oriented investors are bargain hunting.

5) There has been so much liquidity provided by the governments and central banks globally that, as some confidence is restored, all that money will have to be put to work and the trillions of $$ that are currently sitting on the sideline earning close to 0% returns will re-enter the equity market with some urgency.

6) Unfortunately it is tough to predict the timing on this, however my best call will be March or April of 09 (unless an unexpected shock of political or economic significance interferes in the interim).

7) It is tough to stand by helplessly watching and waiting when we are impatient to see improvement.

8) If you have $$ to invest and do not require the $$ for lifestyle needs for at least 2 years, then this is likely to be the best time to put it to work, i.e. be as fully invested in a globally diversified portfolio of good companies as possible.

9) Given the nature of the "melt-down", no asset class (other than cash) has gone unscathed.

10) For now we must wait for the "true" value to return to current portfolios (which will happen eventually) and let the managers make the necessary adjustments.

11) I will be vigilant to make sure that they (the managers) are acting in your best interests.

Hope this is helpful.

Plan, Plan, Plan...and Plan some more!!

A few years ago our team walked a client through a strategy that was, at that time, rather new to her:


She was a wealthy widow (husband had owned and sold his privately owned and operated business a few years earlier and she had inherited the proceeds) with a number of grand-children that she wanted to provide education funding for if they needed it and she was no longer around to make sure that they got it.



She also did not want them to incure any estate or probate costs and was not prepared to risk this money to the volatility inherint in capital markets.



Our team of experts: legal, risk and tax put their heads together and came up with some interesting solutions.



We call this facet of Wealth Management: Advanced Planning.



Wealth Management = Investment Counsel + Advanced Planning

Advanced Planning = Wealth Enhancement (Tax Strategy)
+
Wealth Protection (Risk Mitigation)
+
Wealth Transfer (Estate Planning)
+
Charitable Giving

Our client called me up the other day to thank me for the comfort and peace of mind that she was feeling, now with capital markets melting all around us, knowing that the strategy we had implemented had protected her plans from the current volatility.

Planning to achieve goals by thinking ahead of the curve.

Can we help you find solutions to your financial challenges?

Thinking Ahead Of The Curve

Right now it is incredibly difficult to look much beyond the current tumult in financial markets. My mood swings are lock-step in-synch with the markets, feeling the emotional uplift of hope when the market appears to be finding bottom to be replaced the next day with that awful nauseous feeling in the pit of my stomach as it makes a new low.

I tell myself to move on, but often find my self locked to the tick by tick market movements with my mouth hanging agape in awe of the violence that I am witnessing: de-leveraging, hedge-fund liquidation, mutual fund redemptions.

The "curve" represents what we know now: we are in for a significant economic down-turn led by a consumer spending slowdown, assisted by a fall in house values, tighter lending standards and a likely increase in the number of unemployed (as businesses adjust).

Thinking ahead of the curve is what we must do now to give us the advantage when the turn-around comes.

I just spent some time working through a clients cash-flow needs for the next year. As we were nearing the final stages she turned to me and said: "what a scary experience! But now I feel so much better knowing what to expect."
We took some uncertainty out of the equation.

Forward thinking helps to put us in a mindset that prepares us for the future. We won't be able to be exact, but we have a good idea based on history, which allows us to be proactive and not reactive (which is how we are forced to act when we are unprepared).

How do we prepare?

From an investment perspective there are great companies that have just gone on sale. The great money managers are sifting through them to find value because in six months to a year, these companies share prices will be up in the vicinity of 50% or more from where they are today (that is why Warren Buffett is buying).

But Wealth Management is more than just investment management.

If you own your own business, you have to forecast sales, forecast costs and ensure that the the differences will be positive for profitability. Otherwise you have to make some adjustments. If economic variables are going to impact either of the key inputs (ie. falling sales / rising costs), anticipation of the impact will allow time to prepare your business to meet the challenges.

Similarly, it is essential to understand your future personal income and cash flow needs that may be impacted by a changing economy.

Thinking ahead, you may forsee business profitability slipping, forcing you to be able draw less income. You will have to make some strategic adjustments to your lifestyle in advance to ensure that you have your priority cash flow needs looked after.

Where are the tax opportunities? Tax-loss selling perhaps (against future capital gains). Are your tax advisor and investment advisor coordinating their efforts to take advantage of your portfolio to ensure that in the future you can minimize taxes? Is it a good time to create family trusts and reduce future tax liability?

Have you addressed future risk: to your life, health and ability to work? what is the ultimate impact on your family if you or your spouse were unable to run the business?

Hindsight, they say is 20/20 (everybody has it). How much foresight do you have?
Think ahead of the curve...make a plan.
Need help? Contact me.

"Savvy" Investing

I was flipping through a copy of Chatelaine magazine last weekend and happened onto the horoscope page where I read my (Virgo) October prognostication:

"Your financial savvy will improve the lives of others this month. Projects coming together around the 10th require up-to-the-minute efficiency, which just happens to be your specialty. Powerful people will be suitably impressed."

I do not normally put much into horoscopes, but this one was definitely hitting close to home and what pressure (this month)!

(Savvy – noun : Also, sav·vi·ness. practical understanding; shrewdness or intelligence; common sense)

I do not think my advice is particularly shrewd, but it is full of common sense:

My clients have structured financial plans: we (our team) know and understand their cash flow needs. In times of financial market volatility, like those we are experiencing now, being forced to take a sale to provide liquidity for lifestyle needs can be devastating to the long-term validity of the plan. So we hold a percentage of liquid, money market instruments that allow for this cash flow need. In fact as markets made new highs in 2007, we were selling off small portions of profitable investments to increase our cash cushion (if a correction occurred and new opportunities arose this money could be re-deployed).

As we watch the total value of the portfolio decline (with the current market volatility) I remind my clients of the financial markets' ability to recover (historically), to guard against the emotional reaction of wanting to sell good investments that are being re-priced lower in daily market trading activity and that we have the necessary liquidity to ride out the storm.

The Media will be busy counselling us all on the dire circumstances and the potential for disaster which will seem rather daunting and compel us to re-think our strategy: but history shows that market bottoms are made when selling is the most aggressive and market tops when buying is most euphoric.

Our brains are programed this way: it is our evolutionary psychological make-up. Our natural instincts for survival are to avoid pain. The sight of a declining portfolio is painful, the natural reaction is to cut out the pain: ie. sell.

This, however, is historically proven to be the incorrect action when it comes to long-term investing (especially because our prudent investment strategy has allocated assets accross a diverse spectrum) .

On average, the markets take 16 months (S&P500) to 20 months (S&P TSX) to reach the previous peak from their respective bear market bottoms.

This implies an 18% to 23% annualized return over those recovery periods for the S&P TSX and S&P500, respectively.

Some might be inclined to throw out the old adage: "but this time it is different".
They are right, every market correction or bear market is the reaction to a different stimulus that causes "investor concern" and a loss of confidence.
But it will recover, it always has.

Time is the only variable. So we need to have the appropriate plan that will allow us the flexibility to be able to stick to that plan.

Need help with that plan? Call/email me.

It may not be shrewd, but it is common sense: Savvy