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MAKING CENTS OUT OF THE NEWS
Blog #23
(July 28th, 2011)
Thoughts On Approaching a Landmark in Investment Management
By Tom McAllister, CFP®
This coming Monday, August 1, I start my fiftieth year in the investment business. While I’ve gained much investment knowledge and experience over the years, the learning continues as I continue to practice in this fascinating field. My hope is to share the benefits of my experience and knowledge with clients and other readers of these blogs and quarterly newsletters, as well as with my lecture audiences, by way of “paying forward” the blessings I, even as a senior citizen, continue to receive.
For forty years, the ongoing debate in my profession has raged between those who believe in investment management through mutual funds and managed accounts, versus those who protest that “the average mutual fund does not outperform the markets and that individual stock selection is best.. My contribution to this debate has always been that of course mutual funds can’t outperform the market; they ARE the market! “The market” has no trading and management expenses, so naturally “it” outperforms the entire mutual fund industry which, of course, does have such expenses!
Recent studies have confirmed my personal belief that the better active managers DO outperform their benchmarks. Two mutual fund management companies which have outperformed for decades are the American Funds and the Templeton Funds, which now are part of Franklin Templeton. The better investment managers, over the long term, and taking the same, or less risk (as measured by “beta”), seem to outperform by four percent or so. Subtract two percent for management and administrative expenses, and they still “beat the market.”
For many years, “beating the market” was something I considered my goal as well. However, once I, along with nearly all my clients, had achieved senior citizen status, we lowered our risk tolerance thresholds and became willing to accept lower returns as a result. Generally, lowering a portfolio’s risk tolerance involves including an increased allocation to bonds In the current climate, with bonds failing to return enough to offset inflation, we have turned to stocks with higher dividends, and to some preferred stocks. These days, preferred stock distributions can be more than double those of bonds – even bonds of the same company! The current preferred stock yields of seven percent + compare very favorably to the three percent or so now available in the bond market. Short term bond yields are, of course, even lower; these artificially low yields must rise sooner or later, making intermediate and longer term bonds quite risky right now.
So as I start my fiftieth year, my recommendation is this: Seek out investment managers who have in the past been able to outperform the indices (given the same or lower risk levels), choosing those whose fees are still reasonable. I caution against hedge funds, believing their higher fees and 20% or more share of profits make it nearly impossible for their managers to outperform the markets without taking on much higher risks through leveraging (borrowing additional money to invest) their portfolios. In addition, hedge funds charge those management fees even on borrowed funds.
In looking for outstanding managers, it’s important to recall the old adage, “there is no free lunch.” If it sounds too good to be true, it probably is! Your investment manager should not have access to your funds, which should be held at an independent custodian, such as Schwab, Fidelity, or a bank. These entities should be audited by outside accountants to ascertain your funds are not being commingled or otherwise misapplied. You should have online access to your account 24/7. Of course, no investors’ accounts should be subject to the creditors of the custodian or the manager. You may, and usually do, give permission to the custodian to pay previously approved, reasonable management fees as invoiced on a periodic basis (usually quarterly).
Forty-nine years in this business is remarkable, yet that success means I am no longer young, nor even middle aged. A valid question is “what happens if Tom gets hit by a truck?” My primary investment managers are a second generation firm with whom I go back over thirty years. The father is no longer active in the business as he approaches 80, but his sons, in their middle forties, continue to do an outstanding job for our clients. Those experts handle the day to day portfolios, which I monitor while handling client communication and financial planning.
I use a second manager as well, devoted to special situations and clients. This entity has a 25 year track record and eight employees, including three money managers. I have known the owner for over sixty years and have been closely aware of his investment expertise paralleling my own these past 49 years. Having put all these systems and people in place to assure responsible handling of our clients’ affairs, at McAllister Financial, we continue to seek new investment clients and invite inquiries.
In fact, with all the rapid changes in our economy and in the investment markets, there are many investors who would benefit from more consistent guidance. Please forward this blog post to them or invite them to log into my website at www.tommcallister.com.
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