Sunday, June 21, 2015

Future Father’s Day Fears

In the US, commercial interests have created a day to celebrate Fathers. For me, Father’s Day has been a day of getting together with parts of my nuclear family. Some are from great distances including Singapore. Close friends that feel a family-like cohesion with my wife Ruth and I phone in or send cards. At the moment, all appear to be well and progressing with their lives. While I am enjoying all this goodwill among our extended family, my first fear is that it can’t last.

Uncertain future

The future is and always has been uncertain, it seems particularly uncertain now. While as a human and an investor, I can handle that; what I find unnerving is that far too few people are planning to handle future problems which include opportunities. Today, there are two elements to my concern - terminal values and flight capital.

Terminal values

The purpose of not spending all of our current income and capital is to provide for future spending. As both a Father, Grandfather and surprising at least to me, Great-Grandfather, as well as a trustee for a number of organizations that are chartered for perpetuity, I should be thinking about the ending piles of dollars and other currencies to meet future needs. While it is true that this is not a unique concern of mine, notice that most all of the focus of the investment world is the present relative price of assets and liabilities. Regularly we are told that an asset is attractive because the current price on a relative basis is cheaper than other assets. There is a presumption that the particular price will rise and fill the gap compared with other assets. In my US Marine Corps days I would label that as a tactical movement. Tactics are important in the battle for investment survival, but rarely accomplish the strategic mission of winning the war and creating a lasting peace.

The first major fear

This week’s piece from John Mauldin is about the large and growing underfunding of state and large city pensions. Various governments, both in the US and elsewhere (Greece and most other countries), appear not willing to close this retirement funding gap. There are two issues with this incipient failure to keep the promises made to both government employees and their supporting tax payers. First is that future contracts to deliver pensions appears to be based on what is now clearly false assumptions as to rates of investment returns and the willingness of politicians to get taxpayers to close the funding gap. This present dilemma has three probable impacts on me and our investments that could be beyond our current plans:

a.  Our tax burden will go up.
b. The services we expect from government will decline.
c.  New money that must be invested will likely push markets higher.

I started this discussion about the lack of focus on the terminal value of investments, which I find to be disappointing. However, the discussion above about the pension gap is a clear example of an attempt to project terminal values. Many, but not all private organizations also have granted their employees pensions, and appear to be able to meet their obligations to the older employees and retirees. (Some have reduced their exposures by Pension Risk Transfer contracting with Prudential and other insurance companies.) The larger approach is to put as many of the employees into defined contribution plans; e.g., 401k or similar plans. In these plans normally both the employer and the employee contribute to the plans and have a number of choices of investments products available to select. The employee is at risk to choose the vehicles that will produce the best return based on personal and investment factors. Some will choose well and others won’t. In most plans the choices are institutional grade mutual funds. We can testify that in one case, The Second Career Savings Plan of the National Football League and the NFL Players Association that it has worked out. For the last two calendar years BrightScope has found this plan to be the Number One of large 401k plans. While the criteria for that ranking does not directly include investment performance, without reasonably good investment results for the players the plan would not have grown as it did with Lipper Advisory Services as its investment advisor.

Nevertheless, the individual players and their families are at risk as to the uncertain value of their terminal accounts. I have the very same problem when I invest for my family’s future. I can not honestly say what will be the ending value of their investment accounts. What I can do in my selection of mutual funds and individual securities is in my own mind to focus my selection based on what I believe are likely future values, at least on a relative basis. I believe that more of us professional investors should be focusing on expected terminal values.

Second major fear

This week is the twentieth straight week with net redemptions in equity funds. When looking at the underlying details, the redemptions are largely in domestically-oriented funds which are importantly offset by purchases of International funds. I find a similar pattern in most countries with the main exception of China. When people switch out of their local currency into other currencies it is traditionally a sign of expected trouble in a country. Are they doing this now through their International fund purchases? They may be seeing higher terminal values beyond their borders. As this is a global pattern, one might say the money class of investors is hedging its bets.

Question of the week:
What are your longer term fears?
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