Archive for November, 2008

It seems to me that the world has been thinking a good deal about risk and money lately. We manage money for families. We think of our roll as that of supporting our clients in achieving their stated goals. This is an important contribution, one that we don’t take lightly, and I can say very rewarding when it works as designed. Unfortunately, today is the most challenging period for wealth management of my generation. As I write this entry I realize I am writing these posts on Capital Stories to remember this time and what we did and thought as we passed through it. This is as much then for me as it is for those of you who choose to read.

In my view, fixed income investments have been a significant contributor to the financial circumstances in which we find ourselves today. As interest rates fell to 30 year lows, smart people occupied themselves finding ways to increase yield. They captured more and more risk to do so. When this risk manifested itself, investors and the sponsors of these engineered products took the hit.

Our clients have to be confortable with what we do now. Confidence is the key to future performance in that rash, emotional decisions without vision will cause the greatest losses. What we should review is our allocation to the fixed income asset class. For our clients we will concentrate on arranging maturities so that guaranteed assets mature each year to satisfy their income requirements from the portfolio. It seems to me that if a family can see where their spending money is coming from 3, 4 , 5 and perhaps 6 years in the future, our suggestion is that with the remaining capital, they can have the confidence it takes to let their longer term return assets run the course.

Liquidity…give them what they want

Behavioral finance is the study of how we make financial decisions. Finance professor Dr. Meir Statman spoke at a conference I attended last year and his basic argument is that we are all wired to act poorly as investors. Our fight or flight heritage gets in the way so we need rules and guidelines to overcome financially costly basic human tendencies. Meir generously shares his research and thoughts on his website and through his blog. – Santa Clara University – Leavey School of Business -Statman Profile

One of these rules or policy that I try to keep in mind is to be a liquidity provider. When the market is falling as it is this year, we should think about granting the emotional investor their wish. While the math may seem obvious it is a great mental check to categorize the liquidity preference of your strategy. Are you offering your position with the herd in flight or are you getting a preferred price by buying your position from those who want out…at whatever it takes. When stocks are rising the principle still holds. If a position is unbalanced and investors are fighting to get into what appears to be a can’t lose investment , give them what they wish for. Trading costs will be reduced since you will likely be selling at the offer or better and buying at the bid or better. In addition, your asset allocation decisions will be greatly advantaged by using this mental check.

(Click on the chart to see a bigger version)

This chart represents my attempt at defining a normal or ”equilibrium” return to equity markets. The data starts in 1970.  Each value represents a 15 year compounded return for a portfolio comprised of one  third Canadian equity, one third US equity and one third international equity.  I think this is a reasonable period in that each data point considers at least two market cycles.The lowest 15 year period equals 8.5% and the highest, just shy of 20% compounded return. If this year ended at the values we are at today the 15 year return will be about 6%.

So how can this data help us?  Should we expect better return in 2009 and can we define what that amount might be? Unfortunately, with all due respect to market strategists and technical analysts, the investments markets are not so easily mined . The risk to equities is not altered by recent experience. We continue to have a random outcome in the short term. Cheaper doesn’t mean less risky. As my friend Brad Steiman from Dimensional Fund Advisors likes to say “stock prices have no memory.” While our expected return may be higher after a large correction  it comes with the cost of higher risk.

I think the most sensible approach is to build more efficient portfolios. If we focus getting the return provided by  the broad markets we end up with ample reward to our efforts. Our investment success should not be determined by “when” the return shows up but rather by how we participate when it does.

I will provide more detail on how we build better portfolios in future posts.

Last Friday I had the pleasure of presenting our investment approach as part of a panel discussion on the subject of succession planning for private business owners in the construction industry.  The panel also included Marc Doucet of Doucet Mcbride LLb and Jim McConnery, CA of Welch LLP. According to the Canadian Federation of Independant Business (CFIB) 34% of entrepreneurs will retire in the next 5 years, and in the next 10 years, 66% intend to leave. It is somewhat surprising then that only 50% of entrepreneurs have a written succession plan in place.

Retirement for the owner means one of three things: sell, transfer to a family member, or retain ownership and relinquish all management duties. The benefits of a written succession plan include: protecting the financial stability and value of the business; lowering taxes on the transaction; improving the stability for employees; and finally, continuing a vision for the future. In addition, a well thought out structure reduces liability to the family.

We had a good discussion about the value of goodwill built up by the owner through a lifetime of hard work. For most in the room the view was goodwill should have some economic value at the time of sale. From the point of view of a buyer, goodwill is rarely considered in the offering price. This often results in the sale of assets, not shares.

Once the cash is out of the business, a reasonable and effective investment approach based on a expectation of success is critical.

We have developed a great tool that will help answer the questions;

Will I run out of money?

When can I afford to retire?

Can I maintain my current lifestyle while retired and will it be sustainable?

How much saving should I have at retirement?

For your free copy of our retirement planning tool send me a reply below.

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