portfolio management

The Model Prisoner

© Can Stock Photo / 4774344sean

Model students do all their homework and get top grades. A role model is someone to look up to. Model prisoners earn time off for good behavior.

Model portfolios are a whole different thing.

Model portfolios are the predominant method of managing wealth these days. There is an understandable reason: they can be profitable for the financial firm. Simple to operate, standardized, easy to talk about–and the pie charts look great on paper.

Out in the real world, models have a glaring flaw. Typically, every client in the model owns the same thing—no differences. But there are valid reasons why people with the same investment objective might have portfolios that vary one from another.

For example, our midwestern clients often want to follow the “Oracle of Omaha.” People everywhere would like to own a piece of the hometown company that does well.

A larger source of variation arises from investment ‘holds.’ Think of shares in a leading, well-run company that was trading at an attractive low price years ago. Once purchased, it may make sense to be a percentage owner for the long haul. But after it goes up in value, it is not the bargain it once was, and new clients find better bargains elsewhere.

Or clients may come to us with long-held stocks purchased at low cost many years before. Income taxes would be a problem if they were all sold at once.

These factors and more create valid, useful variations in client portfolios. When we began to build our systems and processes to tailor portfolios to each client, we quickly realized that model portfolios would only be good for us, not you (our opinion). That isn’t how we conduct business.

At 228 Main our research drives the development of rules-based trading protocols that we can effectively apply across client portfolios. Our systems accommodate the concept of the investment ‘hold,’ and your specific instructions about specific holdings. Our rules-based trading helps us aim for the efficiency of models without the drawback of mass standardization, regardless of your circumstances.

Two things help us immensely. You and we seem to be on the same page with how we think about investing—we are a tight group. And the mutual trust is key: you trust us to make the most of whatever is going on; we trust you to persevere.

Clients, if you would like to discuss this or any other pertinent topic in more detail, 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.

Stock investing involves risk including loss of principal.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Things We Do Together

things we do

We figured out a long time ago that three things we do matter the most.

Clients, talking with you is at the top. We connect to understand your situation and collaborate with you on your plans and planning. You are the most important part of our business. Otherwise we have no one for whom to research investments or manage portfolios through LPL Financial.

Research and portfolio management are the other two core activities. Our principles drive both of these: avoid stampedes in the market, seek the best bargains, ‘own the orchard for the fruit crop.’ And both are informed by our connection and collaboration with you.

Although each member of the team serves you in multiple ways, we think of our support infrastructure as the trade desk, the research desk, and the logistics desk. (By logistics, we mean taking care of the details of doing business with you.) These functions connect our main activities.

A funny thing happened when we concentrated on the three activities that are most valuable to you. Less pleasant things that dominate the schedules of most financial types simply disappeared: selling, searching for prospects, marketing to strangers. Ever since, we’ve been able to spend a much higher fraction of our time talking with you and striving to grow your buckets.

If your buckets grow, you like it and our revenues grow. Why waste time and energy on strangers when we can invest it in our friends? It sure raises the enjoyment factor for us.

Clients, we do not know if this is of any interest to you. Writing it helped clarify our thoughts about what we are doing and why. If you would like to discuss this or any other pertinent topic, 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 investing involves risk including loss of principal. No strategy assures success or protects against loss.

We Eat Our Own Cooking

© Can Stock Photo / lisafx

Last week I was describing an investment opportunity, or ‘table-pounding bargain’ as I prefer to think of it, to a client. The client was not exactly skeptical, but she had a question. “Do you own it?”

This is a brilliant question. ‘Skin in the game’ is an extremely vital indicator. When someone is personally invested in an idea or concept, they are more likely to be focused on the potential for success or possibility of failure. Alleged leaders who do not share in the consequences of their actions are notoriously inept. (Congress and health care, for example?)

Modern philosopher Nassim Taleb (author of The Black Swan) takes it a step further and talks about soul in the game. Perhaps my level of compulsion, commitment to work to age 92, and obsession with your outcomes is evidence of ‘soul in the game.’ I’m not sure how I could possibly be more involved with my work.

Do I own it? Lady, I am loaded down with the stuff. I cannot in good conscience inflict the kinds of concentrations on you that I am willing to face. After all, few of you want to work to age 92 as I do, and between you and me, I am in the best position to knowingly run larger risks. So the most volatile accounts in the shop, upside and downside, are my own.

Let me clarify: we offer no guarantees. The fact that I own the ideas we talk about does NOT provide any tangible value to you. When your account grows, our revenues rise—it is win-win—and that provides an economic incentive to act in good faith. But whether or not I own something is no guarantee of anything.

My purpose in writing this is simply to say we may be right or wrong on any recommendation—but we are always sincere. I want you to know, that idea I’m talking most about, YES I own 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.

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

Investing involves risk, including possible loss of principal.

There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes.

Would You Take Every Drug on the Shelf?

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We have written quite a bit about the conventional investing wisdom recently. This essay puts the focus on what we do here at 228 Main.

One of our principles is to find the best bargains. We cannot be sure where they are, but we will still try to find them. We look for seemingly healthy investments at historically low-seeming valuations.

We recognize this means buying investments which are unpopular. This is fine with us. In fact, we rely on it. One of our core principles is to avoid stampedes. The more of something everyone else is buying, the more expensive it is going to get.

A natural consequence of our approach is that our portfolio construction may not be as diversified as conventional wisdom dictates. But we are not interested in trying to own everything. We want to own the bargains.

We may not always be able to pick them. We may miss out on some high flyers because we thought they were too expensive to buy. Sometimes a “bargain” turns out not to be one. Generally, though, we believe that our odds are better if we at least try to find the bargains.

An alternative to our way is like going to a doctor who prescribes every drug he can think of in case one of them works. “Chances are some of them will make things better and some of them will make things worse, but in theory one of them should cure you.” Wouldn’t you run out the door?

There are many unknowns in both medicine and investing. A doctor may have to try several courses of treatment before finding one that works. Similarly, we frequently implement several promising tactics at the same time. Some don’t work out and need to be replaced.

We think it is reckless, however, to simply give up trying to find successful investments in favor of simply grabbing a little bit of everything. Yet that seems to be a popular, if lazy, strategy with some investment professionals.

Clients, please call or email us if you want to discuss how our investment ideas apply to your situation.


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

Investing involves risk, including possible loss of principal.

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.

No strategy assures success or protects against loss.

Change is the Only Constant

pyramid

The ability to adapt to changing conditions is what sets those who thrive apart from those who merely survive.

Our portfolio theory evolves over time as economic and market conditions unfold. The problem with the textbook approach in a changing world is that a textbook, once printed, never changes. Looking at the world as it is and doing our own thinking, we see things in a new way.

We believe that central bank intervention and counterproductive monetary policies have distorted pricing in the bond market and for other income-producing investments. By crushing interest rates and yields to very low levels, the old investment textbook has been made obsolete.

Therefore the classic advice about the proper balance between stocks and bonds brings new and perhaps unrecognized risks, with corresponding pockets of opportunity elsewhere. Yet the classic advice met a need which still exists: how to accommodate varying needs for liquidity and tolerance of volatility.

Our adaptation to this new world is the portfolio structure you see above. Our classic research-driven portfolio methods live in the Long Term Core. We believe our fundamental principles are timeless, and make sense in all conditions.

But people need the use of their money to live their lives and do what they need to do. So a cash layer is needed, tailored to individual circumstances.

The layer between is ballast. This refers to holdings that might be expected to fall and rise more slowly than the overall stock market. Ballast serves two purposes. It dampens volatility of the overall portfolio, thereby making it easier to live with. Ballast may serve as a source of funds for buying when the market seems to be low.

The client with higher cash needs or who desires lower volatility may use the same long term core as the one who wants maximum potential returns. One may want a ‘cash-ballast-long term core’ allocation of 10%-25%-65% and the next one 4%-0%-96%.

The adaptations we’ve made have generated efficiencies and therefore time—time to work individually with you on your plans and planning, time for more frequent portfolio reviews, time for more intensive research.

Clients, if you would like to discuss how this structure might fit your needs, please email us or call us.


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.

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 State of Our Union

© Can Stock Photo / Niyazz

Our union? Yes, you and we are partners in a unique enterprise. As a client, you share our confidence about the long term. Many of you are willing to live with volatility in the short term to get where you want to go. And many of you don’t join stampedes or sell out in panic. This investment behavior puts you in a select group. It is a vital ingredient in the beginning of your success—and ours.

The 21st anniversary of the decision to embark on our ultimate business venture is a natural time to take stock. Where are we now? Where are we going? We’ll assess this in terms of our three key activities.

Communications.

We love to talk—you know this. About two years ago, we began to figure out how to talk to all of you, every day if you would like. The new media has two aspects. Real time commentary and news shows up in the social media venues like Facebook and Twitter. A permanent library of all of our philosophy and strategies and methods can be found 24/7 at 228Main.com.

Paradoxically, the success of our new media has given us more time to talk one on one, by telephone or email or in person. So now we spend more time doing what we love, connecting with you directly. We expect to continue to build both our archives and our skill at real time interaction.

Investment Research.

To a surprising extent, our research capabilities are tied to new media activity. We interact with great minds in economics and market strategy, trading ideas and insights and finding topics we wish to investigate more deeply.

The one-to-one communications with you also contain a research element. We gain perspective on global markets by talking to executives who have traveled the world on business. We have a better understanding of specific industries and companies because we talk to people who are in those businesses. Every one of you is a consumer, and we talk to you about companies and products you deal with every day.

Our conventional sources have never been better, either. LPL Financial continues to build out our back office research staff by adding and developing talent. Bottom line: we are connected to ever-richer sources of ideas and trends as well as the specific data we need to do our work.

Portfolio Management.

Over the past eighteen months we have worked on improving our capability to act more quickly on fleeting opportunities. You saw the results. Our portfolio review process is more robust than it ever has been.

We also have tweaked our strategy. Now, client portfolios see more activity but in smaller pieces. Instead of looking for opportunities where we can invest 5% of a portfolio balance, we will take action if 1 or 2 or 3% position sizes are appropriate. With more holdings comes greater diversification. Theoretically, this may give us a smoother ride to our goals.

The markets are like a thousand piece mosaic whose tiles are constantly changing. So we cannot tell you what changes are coming in the future—only that we will always be trying to figure out how to grow your buckets more effectively.

So the state of our union is grand. We have focused on our systems and processes so we can take care of business no matter what happens in our lives or the economy and markets. We offer no guarantees about the future, except for our intent to get better as we go along. Thank you all for your part in our unique partnership. Clients, if you’d like to talk at greater length about these things or anything else, please email 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.

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.

Art Versus Science

© Can Stock Photo / karandaev

For most of human existence, our primary occupation was trying to get enough food to keep ourselves going. Countless millions of manpower-hours have been spent hunting, gathering, farming, and fishing to put food on the table; millions more were spent preparing, preserving, and cooking.

The upshot of this is, we got really good at it. Thousands of years of practice gave us a lot of room for trial and error. We figured out how to create healthy, sustainable diets from practically every environment on the planet. Every culture came up with their own answer for how to feed and support their population. But if you asked any of them why their diet worked, they wouldn’t really be able to give you an answer. All they knew was that this was how they had traditionally made their food. It was an art, not a science.

As humans we are inquisitive creatures by nature, so some of us were unsatisfied by this answer. So scientists began to study what made our food tick. They isolated essential vitamins and minerals and determined their effects on our body. Armed with this knowledge, they devised newer and more “scientific” diets. According to their theories, we could make cheap mechanically processed food and insert vitamins to give us all the nutrition we needed. We would be free of having to slave away in the kitchen and wind up healthier than ever.

Unfortunately, this never really panned out. It turns out we still don’t understand nutrition as well as we thought we did. We’ve revised our nutritional models again and again, and yet we are still not substantially healthier or wiser than we were when we were slaving away in the kitchen doing things the way grandma did.

This is an elucidating story on the limitations of scientific study, but it also has practical applications for our work. Just as our food scientists try to figure out what makes our food tick, financial professors try to figure out what makes our investments tick. They isolate factors that they believe account for investment performance and construct portfolios on the theory that they can reduce holdings to simple factors and whip up a balanced “diet” that has a little of everything.

Sometimes, the theories work. But anyone who thinks that they have unlocked the secret to guaranteed wealth is going to be just as disappointed as the food scientists who were certain they had unlocked the secret to guaranteed health.

We believe that we are likely to do better by sticking to the same timeless investment principles that our predecessors in the market made their money by. We are not Luddites—we are more than happy to include scientific investment analyses in our research. But we still believe that investment is as much art as it is science.

Perhaps someday in the distant future someone will manage to reduce investment success to an algorithm. Until then, we will trust our “artistic” judgment over what a computer tells us we should buy. If you would like to have an unscientific discussion about this or any other money topic, please call or write.


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

122 Out of 7 Billion

© Can Stock Photo / thesupe87

Of the seven billion people on the planet, more than three billion have access to the internet—including 286 million in the United States1. Any of these millions and billions may read our work and our thoughts here at 228Main.com, no cost.

The funny thing is, we started out writing with a specific audience of 122 households in mind. These are the people who trust us to manage their portfolios and help them frame their financial issues. We began writing these articles to improve our ability to communicate with and serve 122 of you, our existing core clients.

It turns out that there is a pleasant side effect to this process. We find that making it easier to connect with you has improved our capacity. We used to think that the 122 households were about our limit for how many we could take on without compromising service. But as our operations grow more effective, we believe we have been able to deliver better and better service. We now believe we may have room to grow to 160 client households.

We don’t know who will wind up filling our excess capacity, where they live, or what their circumstances are. But we do know a few things about them already.

They will have effective attitudes about investing, or be willing to learn them. In other words, they will fit into our niche market of the mind. They will have a few hundred thousand dollars available for long-term investing, or more. They will understand that we put all of our efforts into trying to grow the buckets and communicating with clients, instead of spending some of our time organizing wine tastings or delivering smoked turkeys or chasing prospects around.

We have long thought we have all the business we need. We do not know what the future holds, though, and the regulatory environment is constantly changing. We do not always believe in the conventional textbook wisdom. Regulations based on the textbook approach may potentially make business more difficult for those of us who would rather try something different. The increased scale afforded by our newfound capacity might be helpful in handling regulatory compliance down the road.

Our work for our core clients is extremely gratifying. If you are one, thank you for the opportunity to serve you. If you may be one of the thirty-eight future clients, please soak up all you can here at http://www.228Main.com. Feel free to get in touch with us via phone or e-mail. And for the rest of the millions and billions, we’re glad you are here, too—you are welcome to eavesdrop while we talk to our clients.

1Data from http://www.internetlivestats.com


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

News from the Trade Desk

© Can Stock Photo / mflippo

 As a hands-on research and portfolio management shop, we develop capabilities that many advisors do not need or have. If we were just finding money and sending it off to a third party to manage, life would be simple (and boring).

From time to time our research uncovers potential opportunities in discounted corporate bonds. The market for these high yield bonds is challenging. At times the market is “thin,” which means there is a lack of buyers and sellers. That makes it difficult to complete the purchases we desire.

Fortunately, LPL Financial has experienced and capable traders on the bond desk. They help us execute multimillion dollar bulk transactions at the best available prices. Buying for many accounts at one time in a bulk deal is a more efficient way to do it.

The opportunity in bonds is somewhat rare. We have only purchased eight different issuing companies in sixteen years. But there is another kind of trading that is relatively constant—the purchase and sale of stock.

The bulk bond purchases led us to a breakthrough in our stock trading protocol. One day we learned at 1 P.M. that a big bond purchase had been completed. We needed to go through eighty accounts and make sales of stock to raise money to pay for the newly purchased bonds. We had two hours before the market closed.

We had devised a protocol (a set of rules) to guide us. The four holdings we liked the least were ranked in order of priority to sell. In each account, we sold in that order until the bonds were paid for. Greg Leibman worked from one end of the list, Mark Leibman worked from the other, and they met in the middle before the market closed.

More recently we adapted the protocol concept to make stock trades. We came to a negative conclusion about an industry we previously invested in—at the same time we uncovered a new opportunity in another industry. We devised a protocol to sell one and buy the other, and completed more than five hundred stock trades in a single day.

The trade desk is where two of our key activities come together for you: research and portfolio management. We are pleased at the continued development of our research. The time we save with effective operations goes back into communicating with you—so call or email if you would like perspective on any money question.


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 market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.

Stock investing involves risk including loss of principal.

Case Study: The Portfolio of Mr. X

© Can Stock Photo / arekmalang

Over the last year or so, you taught us a lesson. We are a little embarrassed it took us so long to catch on. But learn we did, and now we are enjoying the payoff.

The lesson is, some people require a layer of cash or other cash equivalents in their accounts to reduce the volatility and risk of the overall portfolio. We used to see this as a form of heresy against our beloved three fundamental principles. Clients were encouraged to maintain their safety blanket somewhere else, so that we could concentrate on our traditional research-driven, focused approach to investing.

We still aren’t comfortable with market timing, and selling in a panic will always result in an invitation to do business elsewhere. But we finally have started listening to those who desire a portion of liquid assets inside their portfolios, or a layer of less volatile investments.

Mr. X is a patient man who has stuck with us despite our stubbornness. His philosophy nearly matches ours—but not quite. When he visited the shop recently to discuss his desire for a little less risk (again), we explained that we had adapted to preferences like his, and how much cash or liquid assets did he want to maintain in his account?

Mr. X could scarcely believe what he was hearing. He asked if we were really going to skip the part where we argue. When we assured him we would simply carry out his wishes, he was surprised and pleased.

Of course, we discussed the central tradeoff. Higher cash levels will generally result in lower long term returns. Mr. X pondered the issue, and specified a relatively modest fraction of the account to be in cash.

Trading lower returns for less volatility can have desirable effects. The cash layer may enable a person to stay with the overall plan in tough times. Financial confidence is a very nice thing to have, and the cash layer may help address it.

We have not abandoned our principles. We simply came to the realization that we could help more people invest more effectively if we listened to them more carefully. Life is better for us, and more pleasant for Mr. X as well.

If these issues are pertinent to you, please write or call to talk about your situation.


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.