Month: July 2017

Security Selection Doesn’t Matter—or Does It?

© Can Stock Photo / alexh

One of the staples of conventional investing wisdom is asset allocation—the choosing of broad market sectors, determines investment outcomes. Supposedly, the selection of individual securities within each sector barely matters.

We will explain where the flaw is after a little history. The theory dates back to 1986 when the Financial Analysts Journal published a paper, ‘Determinants of Portfolio Performance.’ The authors concluded that asset allocation explained 93.6% of the variation in portfolio quarterly returns.

Since then, others have concluded that as much as 100% of returns are explained by asset allocation, that security selection doesn’t matter at all.

This version of reality is convenient for some financial planners, who are thereby relieved of the work of actually researching securities and managing portfolios based on that research. If it doesn’t matter what you own, only the category, you simply need to choose your pie chart of sectors and buy stuff to fill it up!

Here is the flaw: all securities are owned all the time, by someone. If you look at the aggregate of all investors (or many investors), security selection appears not to matter. But the individual does not own all securities – and the specific selection of what he or she does own has a huge impact on outcomes.

Investor A buys a security for $100, sells it later for $25 to Investor B. Investor B holds it while it recovers to $100. One has a 75% loss, the other a 300% gain. Security selection matters. In the aggregate, the security started at $100 and ended at $100. But that leaves out the loss for one and the gain for another.

One of Warren Buffett’s earliest investors put $15,000 in, back in the 1950s. Today his name is on the home of the symphony orchestra in Omaha, a beautiful performing arts facility he donated to the community. Security selection matters.

We offer no guarantees about the outcome of our work. But we believe the selection of individual securities is the biggest factor in those outcomes. If you would like to discuss this topic or anything else at greater length, email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

Asset allocation does not ensure a profit or protect against a loss.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Another Anniversary

© Can Stock Photo / andreykuzmin

We are on top of the 21st anniversary of the foundation of our enterprise, Leibman Financial Services. I intend to operate it for another thirty-one years. I do what I can to make that outcome more likely to occur.

The future is a mystery, but the past is history we may examine. In August 1996, I began at the kitchen table of our home in the Eastwood neighborhood of Louisville. My biggest assets were all intangible—a curiosity about finance, passion for the markets, and a desire to use these things to help people get where they wanted to go.

Apart from that, we had little. Four kids, a mortgage, a lower level full of the babies and toddlers in Cathy’s home-based child care, and a burning ambition to keep the checking account above zero.

After a couple years, a bedroom freed up when a kid moved out. A couple of years after that, the quaint commercial Victorian building at 228 Main became available—and we bought it. Thank goodness for understanding bankers!

My brother Paul helped me get 228 Main ready for occupancy, and became my first helper. Cathy worked with me for several years, then son Greg Leibman took over when she retired. We are committed to add whatever staff is needed to provide you with comprehensive investment advice and good service. Larry Wiederspan has been a huge benefit on the service front, as Greg’s research and trading duties expanded.

Now, because of your trusted relationship, Mark Leibman of Leibman Financial Services Inc. serves over $65 million of your assets in brokerage and advisory assets through LPL Financial.

Many things have changed over the years. Our focus has tightened on investment research, portfolio management, and talking to you, the three core activities. Our appreciation and affection for you has grown. Our understanding of what we are doing evolves and gains definition over time. But our principles and our motivation are unchanged.

Our success depends on your success. Our only object is to grow your buckets, our best path to increased revenues. From where we sit, it feels like this is working out for everyone so far. Thank you all, for everything. Here’s to the next thirty-one years!

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

Heavy is the Head that Wears the Crown

© Can Stock Photo / tashka

Pop quiz: if Joe Smith from Detroit works for General Motors, who is at the top of his chain of command? His boss’s boss’s boss’s boss, in other words? (I pick GM as a random example, but this exercise is true of any publicly traded company.)

If you own any shares of General Motors, the answer is you, personally. Makes you feel pretty important, right?

Of course, there are some caveats. General Motors has over 1 billion shares of stock floating around, and this is not an unusually large amount for an exchange-listed company. If you only own, for example, 1 share of GM stock you have less than a one-billionth part of the collective ownership authority over the company. Still, as a stockholder you are entitled to a have a proportionate voice in how the company is run, however small that voice may be. It is a powerful idea, and this idea of shared ownership is a cornerstone of our modern economy and way of life.

The most visible parts of your rights and responsibilities as a shareholder are, inevitably, the proxy voting materials that you may periodically receive as a stock owner. Your shares entitle you to vote on the company’s board of directors, as well as other significant decisions that the company may make from time to time.

For smaller investors such as you or I, shareholder materials can sometimes be more of a nuisance than anything else. Even if we got together with all of our clients and voted together as a bloc, we still would not command enough shares to influence a shareholder vote much. Moreover, we would generally want to stick with the default recommendation of the company management. If we disagreed with the job management was doing, we would not want to invest in the company in the first place! There are sharks out there in the investment world that look to gobble up companies and take over their management, but in here we are all pretty small fish—we just look for successful companies that we can swim along with. Most of the time, we are content to leave shareholder decisions up to the big fish.

That said, it does happen occasionally that a vote or shareholder election comes up that may have some effect on you personally. We keep an eye on what shareholder materials get sent out so that we can get in touch if something comes up that you ought to act on.

The bottom line is that the privileges of stock ownership can wind up translating into a lot of mail, and it can be difficult to sort through it all sometimes. Clients, if you receive any shareholder communications that you do not understand, please do not hesitate to pick up the phone or email us for help making sense of it.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Stock investing involves risk including loss of principal.

What You Don’t Know Can Hurt You

© Can Stock Photo / alphaspirit

In 2002 Donald Rumsfeld made headlines when he stood up during a press conference on the case for war against Iraq and proclaimed “there are known unknowns.” At first, this phrase sounds like a silly oxymoron. However, it actually makes a very important distinction. Whenever we are considering our planning, it is important to acknowledge both the risks that we know—the “known unknowns”—and the risks that we don’t—the “unknown unknowns.”

For example, suppose you are thinking about investing in an airline company. You are probably aware of a number of possible risks to an airline: natural disasters, plane crashes, or spikes in fuel prices, to name a few. These are your known unknowns.

Now imagine what happens to your investment if you buy airline stocks and the next day a scientist announces that they’ve built a teleporter that can safely and instantaneously transport people across the globe. Nobody could have foreseen such an outlandish invention—it would be something straight out of science fiction. This would be an unknown unknown, a risk that is so far off your radar you probably would not even think it was worth thinking about.

And you may be right. These risks are by nature rare and unpredictable, so it is practically impossible to plan around them. But it is important to remember that they can and do happen, and to be ready for the possibility. There was a point when heavier-than-air flying machines seemed like an impractical fantasy. Those who bet against the airplane wound up paying for it eventually.

Today, investors and advisor representatives have a wide range of tools to try to quantify the risks of a portfolio. These forecasts are only as good as the models behind them, though—they can only estimate based on the known unknowns, not the unknown unknowns. There is certainly some value in statistical risk analysis, but there is also a real danger in false confidence.

As humans we are pretty bad at understanding probability: a 5-10% chance sounds pretty unlikely, but in practice a 1 in 20 chance is not nearly as rare as we think it is. When we hear numbers like 95% we tend to think of them as being a safe bet. That’s not much comfort if you turn out to be the 1 in 20, though.

Here at Leibman Financial, we have a different approach to risk analysis. It goes something like this:

Everything we invest in has risks. Many of the investments we prefer are more volatile than average. You may lose money.

We do not make these statements because we are fishing for excuses. We are proud of our results and stand behind them. We want you to continue to do business with us, and believe the best way to ensure this happens is to make money for you.

We like to think we do a pretty good job. But we cannot guarantee our results, and we will not inspire false confidence by guessing numbers for you. If you have any concerns about investment risks, feel free to call or email us and we will discuss them to the full extent of our knowledge and understanding.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

Stock investing involves risk including loss of principal.

The Rear View Mirror and the Windshield


Nobody we know would drive down the highway with eyes glued firmly to the rear-view mirror. The mirror tells us only where we’ve been. The windshield, on the other hand, gives us information about the road ahead.

Yet an investment method popular with many financial representatives and firms relies on a combination of rear view imagery and elaborate statistical calculations. Years of data about the behavior of different investment sectors is fed into a computer program, which spits out the optimal proportions for ownership of every sector. It is said to deliver hopes of the best returns for a given level of volatility.

We see three flaws with this method, called Modern Portfolio Theory or MPT.

The future will not be like the past. MPT is really just high definition, computer-assisted hindsight. It tells you what would have worked up to now, by looking only into the rear-view mirror. Many financial crises provoke a lot of disappointment in people with MPT portfolios.

Our behavior changes with our experiences, thereby changing the future. It was thought going into the 2007-2009 financial crisis that mortgages were safe investments because people always paid them first, even if they couldn’t pay other bills. In reality, auto loans outperformed while mortgages went unpaid. Consequently, the next crisis may well feature large losses in auto loans as too much capital has poured into this ‘safer’ category. MPT cannot see these kinds of dynamics.

People attribute more certainty to MPT computer output because it calculates portfolio holdings and potential variation in account value out to two decimal places. They forget that these are estimates. Adding detail to what is basically a guess does not make it more accurate.

Clients, you have heard us talk about our three principles over and over again. They help us assess the economic and investment landscape. They give us a way to think about how the future might unfold. Although we have no guarantees to offer, or even assurances that our methods are better, at least we are trying to look out the windshield—instead of focusing on the rear-view mirror!

We would rather figure out how to live with volatility and aim for higher returns instead of pretend that focusing on the rear-view mirror will save us grief in the future. If you would like to discuss your situation in more detail, please email us or call the shop.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing involves risk, including possible loss of principal.

We Work Hard for the Money

© Can Stock Photo / lunamarina

Clients are familiar with our work in high yield corporate bonds. Since 2001, we have identified eight opportunities in the sector. We put more than $10 million to work by purchasing more than $20 million of bond face amounts at a discount, issued by these eight companies.

To be clear about the terminology, ‘high yield’ is a polite way to say ‘JUNK.’ Bonds do not sell for 70 cents or 30 cents on the dollar unless there are some issues that place the outcome in doubt. The conventional wisdom says that people should not purchase individual issues of junk bonds because of the risk involved.

This arena is a contrarian’s dream. We human beings know how to take things too far—it is one of the things we do best. To illustrate, when the price of oil fell from $140 to $100 to $60 to $30, the news was full of predictions that the price would fall to just $9 per barrel. Bonds issued by an oil exploration and production company fell to 30 cents on the dollar, then fell even more.

You already know we believe the crowd can be wrong, and the stampede is to be avoided. Our analysis of the company financial statements said that even if the oil company went broke, at $9 oil then bondholders would still probably recover 30 cents on the dollar in a liquidation. Since negative sentiment about oil prices had gone way too far, in our opinion, we concluded that oil was NOT going to $9 per barrel anyway.

Oil bottomed, the bonds bottomed, both rose. Clients, you noticed this in your 2016 statements. When we find an anomaly between what we expect will happen and what the market has priced in, profits may result.

What you do not see is the process by which we found the eight opportunities over sixteen years, and how we go about finding the next one. We recently found 199 high yield bonds offered for sale by 29 different issuing companies that met our first criteria. We seek 10% or higher yields, and 25% or greater discounts from face amount.

Smaller companies or issues of bonds that do not trade with sufficient liquidity are thrown out. Companies that lack an asset base from which creditors might gain a recovery are ruled out. And certain industries are judged too risky, based on the economic cycle.

The bottom line is, we need to understand how we would get our purchase money back even in the event of liquidation. If a bond issuing company ultimately cannot pay back the whole dollar, it goes broke. Creditors including bondholders get paid first, before stockholders. So if we buy in for 50 cents on the dollar and receive 75 cents back in a liquidation, we make money.

For each bond issuer, we need to understand the capital structure of the company. This tells us where the bonds rank in liquidation priority. We need to analyze the financial statements. What assets would be available for liquidation? Would the company make money if its debt was recalibrated to market value? We also must consider company management, and think about how well it would maneuver through a reorganization.

The title above says we work hard for the money. What we are talking about is the recent exercise where we looked at the 199 bonds of 29 issuers, went through our analysis to see if we could find a new opportunity…and came up empty. This is usually what happens.

We have looked at thousands of bonds issued by hundreds of companies over the years. Eight times in sixteen years, the stars lined up for us (and for you.) The search goes on, the next opportunity will pop up sooner or later. If you would like to talk about this or any other issue, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

Investing in mutual funds involves risk, including possible loss of principal.

Two Robbers Lurk in the Shortcut


The investment methodology promoted by most financial professionals has a costly shortcut at its core. A mathematical trick is used in place of common sense, one that simply equates volatility with risk.

The shortcut enables people to pretend that statistical models can predict the future risk in any portfolio. The model always works perfectly, until it doesn’t. Three Nobel Prize-winners using these kinds of models blew up a hedge fund with billions of dollars in 1998. The failure of Long Term Capital Management caused an international crisis.

Warren Buffett wrote a wonderful analysis of this issue in his 2014 letter to shareholders. He explained that stock prices will always be more volatile than cash holdings in the short term. But he believes that fixed-dollar investments are far riskier than widely diversified stock portfolios over the long term.

One of the robbers that lurks in the shortcut is inflation. A dollar today will only buy 98 cents worth of goods next year, and 96 cents the year after that. Buffett wrote in 2014 that the dollar had lost 87% of its purchasing power over the previous 50 years. So over the long haul, the stable fixed investment becomes quite risky in terms of the potential to melt your wealth away.

While the high risk in currency-denominated investments did its damage, the same 50 year period saw the S&P 500 advance by 11,196%. Another of the robbers lurking in the shortcut is missed opportunity for long term gains.

Fortunately, you can spot the shortcut fairly easily. Every one of the following situations involves costly confusion about volatility and risk:

1. When every market sector supposedly needs to be owned for proper diversification. Our view: Some sectors are overpriced and should not be owned—tech stocks in 2000, real estate in 2007, commodities in 2011, and so forth.

2. When the presence of declining elements in a portfolio is held as proof of proper investment process—the idea that some things always zig when others zag, and keep the whole bucket more stable. Our view: When a crisis hits, many things decline across the board.

3. When a short-term decline is spoken of as ‘a loss.’ Our view: This is a costly misperception, born of a short-sighted approach.

4. When the future returns of a portfolio are described as a range that will be accurate 95% of the time—this is a hallmark of the statistical model. Our view: The model knows the past. The future will be different than the past. The wheels will come off the model when these differences emerge.

No one knows what the future holds. Our approach is to avoid stampedes, seek the best bargains, and strive to own the orchard for the fruit crop. These principles help us pick our spots, so to speak, rather than think we need to own a little bit of everything no matter what. The principles are no guarantee against loss.

The key advantage in our method, we believe, is avoiding the robbers who lurk in the shortcut. No systematic wealth melting from unneeded stagnant fixed investments, no missed opportunities for long term gains. We have no guarantees that our approach will be superior.

Clients, you know that one thing is required of you in order to have a chance to be successful with our methods. The understanding that volatility is NOT risk is key. Please call us or email if you would like to discuss this at greater length.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.