Investment Strategy & Tactics

Introduction

Developing the best strategy and tactics for our clients’ investments is never far from my mind. Thus, Saturday night at the annual birthday dinner for George Washington at Mount Vernon,  I listened to and spoke briefly with David Rubenstein, the co-chair of the Carlyle Group, a very generous contributor of his time and fortune to numerous non-profit organizations.

This was the second time in the last couple of years Mr. Rubenstein spoke at this dinner.  During the first he discussed his $10 million donation to Mount Vernon,  a non-government supported charity to maintain the General’s estate and the legacy of his incredible contribution to the success of the United States. In the Saturday evening keynote discussion Mr. Rubenstein labeled George Washington as an inventor which in today’s consciousness is higher than general or president. The three “inventions” that he is crediting George Washington with were: 

(1) The creation of the first organization that the thirteen very separate colonies had was the American Army, which when paid and equipped were much poorer than the various colonial militias.

(2) The political drive to create the US Constitution which for the first time created an executive government ruling with the consent of the Senate.

(3) The rotation of power; setting a precedent in declining a third term or life-term as President.

Translating David Rubenstein’s three Washington’s inventions into investment focuses I came away with the following thoughts:

To win a war of independence it is necessary to have sufficient sized forces to eventually win the war even though various battles may be lost.

What was not lost was the battle for survival. The second invention, while written by others, was adopted by the Second Constitutional Congress chaired by George Washington and stressed the need for controls and appropriate consultation without great interference with executive execution.

You will see these inventions are similar in logic to part of our development of L Timespan Fund  Portfolios ^TM (Lipper Time Span Portfolios) but before we discuss one of these portfolios, we should recognize that this past week demonstrated that the surge that was mentioned last week has begun.

The surge

In last week’s post I discussed the one main missing element to the surge that can lead first to a significant price performance of 20%+ (which will be followed by a larger decline). During the week both the Dow Jones Industrial Average and the Standard & Poor’s 500 went to new high readings. European stock indices are at a seven year high, Japan’s market is also at a high point and the UK’s FTSE 100 is only 15 points away from a new high. These global price moves suggest that many investors are showing profits in their aggregate portfolio. Many investors with cash on the sidelines or invested in bonds are very likely to be worried that they are being left behind and will commit to purchasing stocks or equity funds of various types.

To create the desire to buy at elevated prices one needs to have increasing confidence in the future.  My old firm, now known as Lipper Inc., a ThomsonReuters company, has four separate growth fund classes based on the average market capitalization of the stocks in their portfolios. In a market where last year’s big long-term winner (Government bonds) are essentially flat through the 20^th of February, the four growth fund averages on a year to date bases are up between 4.18% and 5.16%. A tight performance group of leaders, the four Small Company Growth fund groups are slightly behind. (I expect that some time during this surge they will lead.)

While performance numbers may be a spur to some, many others need an enthusiastic story to lure them into the marketplace that has already seen a significant advance. The classic case is Apple which I have owned for many years, but have no special knowledge about. Carl Icahn, currently a multi-billion dollar owner of the stock, has been publicly touting an eventual price of $216 compared to the current price of about $129. The media is jumping on with a story in this week’s Barron’s suggesting that the stock could rise 25% this year. Others state that the stock is selling at a discount to its value with the forward price/earnings ratio of 14.7 times. I have no idea whether any of these projections will come true, what I am focused on is that these and similar stories on some other stocks can be the propulsion of enthusiasm which is needed to create a major top.

To me, the surge is on. Be careful how one dismounts this animal, many have done it unsuccessfully.

Creating successful portfolios through science and art

For a long time I have been constructing investment portfolios for institutions and individuals, often using tools that David Rubenstein credits George Washington with as his inventions. One of our readers, a professional portfolio manager has asked how we would construct our time series portfolios. Thus this week I will outline, in many ways the single most important of the portfolios, the Operational Portfolio.

All of the time span portfolios should be viewed as platforms that within their bounds can have aggressive or defensive positions or some combination of them.

Great portfolios are the results of the interplay of science or if you will, numbers and ratios as well as future-oriented judgments. All great artists be they musicians, sculptures, or painters use both schools to reach the desired result.

The Operational Portfolio is designed to meet the current year’s estimated spending requirements and a reasonable guess as to the following year’s needs. In all likelihood these needs will consume all of the capital and income of the portfolio. Even under the best of circumstances surprise demands for spending will occur. Thus all investments in the Operational Portfolio must have weekly, if not daily liquidity and therefore should be reported weekly to the authorized spenders. Because of liquidity concerns at least half of the portfolio should have stop loss orders or similar arrangements, such as  “Good ‘til Cancelled” (GTC) which should be monitored at least weekly.

Clearly this Operational Portfolio is critical to the current needs of the beneficiaries. One can assure more comfort to these spenders and their guardians by increasing the size of the portfolio. However, any increase in size of the Operational Portfolio will decrease the capital to be invested longer-term at higher returns. This may well be the place where George Washington’s type of skills are needed to produce the most effective compromise for the good of the whole effort.

I have said that these Timespan portfolios are platforms which can be populated with various combinations of aggressive to defensive securities. The defensive issues could include US Treasury Bills of various maturities, insured deposits of sound banks and the highest quality portfolio of commercial paper. The aggressive securities could include short-term loan participation portfolios, some broadly based index funds and perhaps some ETF-like vehicle that has a larger mutual fund (which could provide liquidity to the ETF if there was a redemption run on the ETF) and Foreign US dollar pay or hedged short-term foreign treasuries. Populating the specific portfolio for the client is where the art form will shine.

The other three Lipper time span™ will be discussed in future posts.

Question of the week: Do you see signs of a surge?

__________    

Did you miss my blog last week?  Click here to read.

Comment or email me a question to MikeLipper@Gmail.com .

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Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Reading the Market Surge

Introduction

We all look at the world first through the lens of our experience. Even while I was still on active duty in the US Marine Corps I read Barron’s weekly whenever I could find it in oversea ports or posts within the US. While the articles were of interest, the back part of the magazine had and still has within it the most comprehensive pages of weekly market and economic data. When I started to look at mutual funds as clients for my research analysis pieces some fifty years ago, I tried to create a similar compendium of fund data. Thus, today I look at the global stock and bond markets first through reviewing fund data to get my bearings.

Six weeks into 2015

Dow Jones has combined a good bit of the Barron’s data with its own statistics and includes in its online Market Data Center mutual fund indices and investment objective averages from my old firm. Through Friday the 13^th of February there are four fund types that are up between 3% and 4 %. These are three growth-oriented fund groups that are labeled Growth funds investing in various sized market capitalizations, excluding Small-caps; plus a fourth group investing in Science and Technology companies. The only fund classification to show better results, (surprising to some) are the International funds, up 4.14%. What implications do I draw from the data?

Growth vs. Value

Over very extended periods of time those funds that follow the growth religion produce roughly the same long-term results as those followed by the value investors. To the extent that value does somewhat better, it may be a function that in their portfolios there are stocks that are acquired while growth companies (using their higher valued stock) are the acquirers. The plain truth, on balance, is that acquisitions don’t work out for the acquirers. However, the rotating performance leadership between growth and value investors can inform investors as to where we are in the sinusoidal, or if you prefer, cyclical market unfolding pattern. The single most important touch point for a value investor is current price relative to the estimated intrinsic value of the company. The growth investor's first focus is what the future is likely to bring to the investment under consideration. In markets that are fearful of a return to periodic declines, the pragmatic skills of the value investor are rewarded. They are very much “now” people. The growth investor lives in a world of expectations. These two polar opposites lend themselves to the currently popular designations of “risk on” or “risk off.”

"Risk On" phase

Have we entered a risk on phase? The Growth fund leadership suggests we have. The NASDAQ market index has rallied more than the more senior exchange indicators. (Part of that is due to the preponderance of Science & Tech plus Biotech issues listed there which may suggest that in time Small-cap Growth funds will be part of the leadership group.) The broadest gauge of the US market, the Wilshire 5000, went to a new high last Thursday. Other “Risk On” indications may be in weeks of rising US dollar values, when mutual funds are regularly seeing redemptions of domestic-oriented funds and money pouring into International funds. One doesn’t do that if one believes that globe’s leading equity market will be collapsing. Even Bond funds are participating in the move to take on more risk with flows into High Current Yield portfolios and withdrawals in some other types of Bond funds.

Is this bullish or bearish?

The plain answer is both. Markets rise on the basis of renewed hope and accelerating expectations of very positive future results. As regular readers of this blog may remember, I have felt that the lack of great enthusiasm has protected us from more than a normal 25% or so drop which regularly happens in most decades. For a bigger decline, of a once in a generation type, we will need to draw many more people into participating into the enthusiasm. Some will quit their day jobs to trade the market. Families will rearrange their long-term safety nets to participate in new wealth and advanced spending. This is not happening yet.

Future clues

The fund flow data mentioned above has within it some useful clues. The aggregate data mentioned includes both the traditional mutual fund data and their newer and more institutionally-oriented Exchange Traded Funds (ETFs) and similar products. While the combined data is showing “Risk On” characteristics, it is  being driven by the materially smaller ETF community and by much more active, trading-oriented hedge funds and similar managers. In many cases these traders are relatively short-term holders of these vehicles as they are using them as substitutes for more expensive futures with less liquidity. A much better clue will be the morning coffee klatch and cocktail parties and social receptions where the loudest talkers will be bragging about their “brilliant” purchases of individual securities or hedge or mutual funds.

Individuals: What to do?

To your own self be true. Individually most of us have gone through a number of downturns and thus tend to be more value-oriented than growth buyers. Stay with what you know and be prepared to pick up deep bargains if they appear. Others that are schooled and comfortable with science and technology can have a reasonable portion of their wealth in growth and have the wisdom to understand and take advantage of periodic disappointments.

Institutions: What to do?

As investment committees are made up of individuals with different backgrounds and investment proclivities, some combination of the two approaches is often the best. The approach that we recommend has to do with our series of time span portfolio constructs. In both the Operational and Replenishment Portfolios it is reasonable to assume a market decline is coming followed by a recovery. In view that we have not had a shakeout since 2009, one should be expected. These two portfolios should be as small as possible to meet current and replenishment needs. More of the sound, long-term institution's needs should be in the Endowment Portfolio with a time horizon of fifteen years and the Legacy Portfolio for the next generations' needs. These portfolios should not be utilizing market timing approaches and should invest for the long run.  By definition there are too many sold out bulls in a recovery.

Question of the Week: Will your current portfolio wisely handle the next bull and bear market?

__________    

Did you miss my blog last week?  Click here to read.

Comment or email me a question to MikeLipper@Gmail.com .

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Focus for Investment Victory

Introduction

Often the most focused player wins the competition. (This is why years ago, I gave up golf, despite the occasional good shot, I couldn’t stay focused shot after shot and hole after hole.) I do try to be a keen observer of the investment game. Few, if any investors with a public record can stay intensely focused on all three parts of the game, I know I don’t. The three parts are: (1) Recency (a new word for many of us about the current picture), (2) avoiding mistakes, and (3) anticipation.

Recency

The media and therefore most individuals including many in professional roles spend their time on the headlines of the day. Far too often they make transactions going within the flow of the so-called news. This is somewhat understandable as they believe as most traders believe, that a security is exactly worth its current price; to which they add their impressions of the impact of the latest news element be it economic, political, corporate, governmental, or in some cases important sports results. While there are some skilled in the art of the trader, far too many go with the direction of market prices. I find that this is often a mistake as the market has already discounted the so called “new” development. Further, normal to enlarged rates of volatility cause quick reversal of recent transactions. As one goes with the crowd, bid and asked spreads widen plus commissions add to the cost of unwinding a trade. Our fund data does not directly capture these actual costs. However, with mutual funds and other professional funds, transaction turnover rate data is available. As I have previously mentioned there are a few rare individuals who manage money for others and have continuing trading skills. All other things being reasonably equal,  I tend to avoid high turnover rate funds. As each market segment and type of security is different, one should determine high turnover compared with a fairly wide sample of peers.

In our construct of four generalized time-span oriented portfolios, the Operational (1-2 year time span) and the Replenishment (2-5 year) Portfolios need to pay attention to current prices and near-term trends thus could tolerate some high turnover rate fund selections. There is no need for this type of talent in the Endowment Portfolio (5-15 year) and Legacy Portfolio (beyond 15 year to multi-generations). In a recent post  I suggested that a long-term oriented portfolio should increase its combined energy commitment from 7 to 10%. At today’s oil prices many of the energy related stocks have gained off of a recent bottom and some are mirroring the 20% rise in the price of oil. If this was a shorter portfolio I might start to be prepared to capture the gain off the bottom. But since, in my mind, this is a long-term portfolio in which I was prepared for a 20% further loss, I would continue to hold on to these cyclical positions for a number of years into the future.

Avoiding mistakes

This is the investment equivalent of the medical Hippocratic Oath of doing no harm. Today the investment application of this crowd-following doctrine is indexing or at a slightly higher fee level, closet indexing. Similar to the Prudent Man Rule proclaimed in the 1830 case that Harvard College lost; one should do what others are doing to avoid criticism and surcharge. This precept is based on the belief that the crowd is right, as demonstrated in securities indices. The weight of wisdom is now placed on the shoulders of the publishers of securities indices to make the right selections with the right mathematical formulas and updating mechanisms. I was able to build a reasonably successful business comparing funds utilizing Judge Putnam’s rule for my clients’ investments and more drawn to an earlier natural law first put forth some 41 years earlier. Benjamin Franklin in a letter written in French to a French scientist said in 1789,  “Nothing is certain except death and taxes.” Thus, I have difficulty locking my clients into a mechanistic formula.

Since we are looking at investing through historical lenses, allow me to bring up a major change to the way the investment community has changed over the last 40 years. On April 1st, 1975 the final element of the SEC-mandated end to fixed brokerage commissions came into force. The first element came into operation on December 5^th, 1968. A little background is useful in understanding the regulation which produced the opposite result than what was intended and has materially changed how the stock markets work around the world.

The official reason to introduce brokerage commission competition into the market, (neglecting that there already was vigorous service and capital competition) was to lower the cost for the retail public. A number of the traditional financial institutions like trust banks and insurance companies wanted to cut into the profits of brokerage firms who were attracting some of their best investment people to join  “The Street” at higher compensation than they were being paid. I will be happy to discuss with our subscribers how things evolved, but the key to this item is the twin recognitions that, excluding retirement accounts, there is very little retail listed equity agency business being done today. The traditional institutions have lost share of market to brokerage firms' wealth and asset management arms and to  the phenomenal growth in hedge and private equity funds. These newer players, through the use of technology, exchange traded funds, and borrowed capital, have introduced a much higher level of volatility and share price competition at the same time as the retail investor’s total investment costs have gone up. In the next major market decline the all-invested market indices are likely to have a fate similar to large war time bulk shipping at the introduction of faster, more accurate torpedoes.

Anticipatory investor

Perhaps it was my scanning the morning workouts at the local race tracks and the past performance records or some things that my brother told me about the Marine Reconnaissance training and battles; whatever the reasons I feel a need to look for what others are not seeing.  (USMC reconnaissance troops are now part of the US’s growing Special Operations forces.) One of the lessons that I learned was an understanding that in the Mexican-American War Robert E. Lee found a sunken (hidden) road by personal recon which let him to move his troops much closer to the fortified Mexicans than they were expecting and win an important battle. 

With these elements in my mix, I keep looking for what others are not seeing. Steve Jobs and other entrepreneurs do this regularly. While I do not believe anyone can accurately predict the future, I do believe that if one focuses on some of the elements that could change and locates some of the change elements, it will be the equivalent of finding that sunken road.

This anticipatory gene should play out on the Legacy Portfolio to produce a stream of income of multiple generations for the institutions and families (including my own) that I am involved with. To capture these results one must be patient. However, I am very conscious that to many there is no difference between being too premature and being wrong. That is why the great artistic masterpieces take a long time to develop.

Question of the week: Please share privately how much of your risk capital are you willing to invest in anticipation of change.

__________    

Did you miss my blog last week?  Click here to read.

Comment or email me a question to MikeLipper@Gmail.com .

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Learning is the Key to My Investing

Introduction

You are probably a recipient of lots of uncorrelated information and impressions. I am as well, but because of my obsession of always thinking about investing for clients I try to find investment inputs to almost everything that comes my way.  Most often I attempt to see available information, in other words inputs that others don't see.

My sense of this past week is that we are transitioning into more dynamic markets and there are growing forces that will stampede equity markets. Thus I am maintaining my market prediction that some time within 2015 we will see a + 20% to -20% or both movement in equity markets.

Lessons from weather

As beauty is in the eye of the beholder, the impact of weather is very much influenced by location and preparation. When I finished last week's blog, in the greater New York area we were dealing with excited announcements of a forthcoming blizzard. (Quite possibly the loudness of the warnings of an incoming multi-foot blizzard was due to the underreporting in 2012 of the oncoming storm "Sandy" when we lost electrical power for two weeks and New York had a particular subway inoperative for a year after the storm hit.)

When last week’s “storm” deposited only a smattering of inches of snow, many within NYC were upset with the closing of schools, offices, and subway lines. For some, if there was not the severe impact predicted, it was like it didn't happen. For those at the eastern-end of Long Island and much of New England the multiple feet of snow was a very different story. Even Nantucket, a summer home for the rich and famous lost all boat and plane connections to the mainland along with loss of electric and communications.

Because the airlines were fearful of a blizzard, they cancelled many flights (including our own) for what would have been the second major day of the storm as they were repositioning their planes to safer spots. Luckily for us our travel agent was able to secure two seats on one of the last flights out of Newark Airport.  Afterward, East Coast to West Coast travel was suspended for a considerable time.

I believe that there are numerous investment lessons one could learn from this and many major storms:

1. Location of persons and assets is critical to risk exposure.

2. Uncertainty is normal and we mislead ourselves believing in a high degree of certainty, particularly when expressed in finite numbers.

3. While the "official' forecasts displayed a range of possible outcomes, the media and their brothers/sisters in the political structure focused only on the most draconian possibilities.

4. In the right environment,  people panic.

5.  Recovery is normal after severity.

We will see whether the storm predicted for today and tomorrow in New York, New Jersey and New England will be real.

Misreading economic forecasts and data

During the last week, the Director of the Congressional Budget Office testified to Congress on the Budget and Economic Outlook: 2015 to 2025. There was little commentary within the investment sandbox because he did not see rising deficits until 2018. However, to those considering our TimeSpan L Portfolios ^TM approach, the forecast is relevant to the third segment, the Endowment Portfolio, which is designed for investing from five to fifteen years. I have less confidence in the Director’s numbers than I do in his projections as to what will cause the deficit to rise. His four key factors were:

 
1. Retirement of the Baby-Boom generation (most however, won't be able to leave economic production)

2. Expansion of federal subsidies for health insurance

3. Increasing health care cost per beneficiary. (means greater longevity)

4. Rising interest rates on federal debt

My US Marine Corps heritage and concerns about worldwide threats make me wonder how we can avoid a major increase in military and related spending.

Further we live in a dynamic global society where change is accelerating. One example can testify to some of these changes. According to the Financial Times, in 1960 GM was the most profitable US company with earnings of $7.6 Billion. In 2013 Apple^* was the leader with $37 Billion. (If one annualizes Apple’s current quarter's rate the profits would double for its current fiscal year.)  To me if one works the numbers, the profit per employee is staggeringly different; $12,666 for GM in 1960 and $399,568 for Apple in 2013. Part of the profit growth is that while both companies are global, Apple is getting much higher profit production than GM. Thus, I am seriously questioning the CBO's future estimates. I would be much more comfortable with a wide range of estimates, with some recognition of the level of uncertainty.  (I hope I learned from the blizzard last week, that the same storm, or passage of time, could give me the different snow fall results from Boston to New York.)

^*Owned personally or by the private financial services fund I manage

Fund investors and traders are not waiting for clarity in 2015

The following data points show different attitudes:

1.  In the week ending January 29^th, US fund investors added $8.9 Billion to Fixed-Income and $3.1 Billion to non-Domestic Equity funds while withdrawing a little from Domestic Stock funds. On a performance basis, the average International fund on a year-to-date was up 1.75% as the only General Equity fund to rise. (A number of Specialized or Sector funds also rose.) Bond funds are continuing to show good performance this year led by General US Treasury funds and Corporate Bond funds.

2.  One of the ways to measure bearishness is to calculate the ratio of the size of short sales to the average daily trading volume. I pay particular attention to this ratio for the more speculatively priced NASDAQ traded stocks. In the last reported period, the ratio was 6.54 days, up +27.9% from the prior reporting period. While this indicator is expressing a bearish point of view, it also identifies the level of potential buying that must come into the market to collect or cover bets. If the short ratio gets to be large, one could see a sudden spike rally.

The Super Bowl is different in 2015

While I have watched and attended  numerous Super Bowls, this one is going to be very different for me. In the past I hoped the officials made good calls on contentious plays and I hoped that the television commercials would produce added volumes for the advertisers and earnings for their shareholders. Like a professional sports game with poor officiating, in the investment arena a sound game plan can lose. The single most important contributor to the sport's revenue is the various television contracts, each collectively bargained contract determines how much will go to the players and their retirement needs.

This year I can concentrate on the playing skills of the two superb teams with quite different tactics and strategies.  The reason for the change is that after 20 years of good performance and service I resigned as investor advisor for the defined contribution plans of the National Football League and the NFL Players Association.

Question of the Week: I appreciate what you have shared with me in the past. Are there particular current items that you follow that determine your long-term strategy?

__________    

Comment or email me a question to MikeLipper@Gmail.com .

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.