HOFFMAN,
WHITE & KAELBER FINANCIAL SERVICES, LLC
INVESTMENT
managers & WEALTH Advisors
February 6, 2006
This is the February 2006 monthly Wealth Management newsletter from Hoffman, White & Kaelber Financial Services, LLC. If you do not wish to be included in our circulation, please reply indicating your desire to be removed and we will be happy to oblige. Alternatively, any of your friends or colleagues may receive this on a regular monthly basis by sending their name and email address to info@hwkfs.com. Feel free to forward this to any of your friends who may find it useful. Thanks for your interest and I hope you enjoy the letter.
“If you
want to build a top-performing mutual-fund portfolio, you should start by
hunting for top-performing funds, right? Wrong”, writes Jonathan Clements in a recent
Wall Street Journal article. "If
you just buy the best-performing funds at one particular time, you'll end up
with a lot of funds that look quite similar. You end up with what's recently worked well. But the funds may not fit with your investment
objective and they won't make any sense as a portfolio."
We've all
heard of someone who bought stock or held real estate at the right time and
made a lot of money. We may have dreamed
of finding the next hot investment and retiring early in style. This one-shot hope to hit it big strategy is
for the gambler. On the other hand, a
savvy investor’s primary, or core, strategy will involve asset allocation. Over time, most gamblers will not succeed;
however, most savvy investors will.
As a
concept, asset allocation is a strategy whereby investors have their assets
broadly diversified among many asset classes so that whatever happens in the
economy, there will be some asset class or classes that they will be able to
gain value from.
If you’re a
gambler type, don’t worry, I’m not trying to convert you. But if you’re a gambler because you don’t
know that you are, then this is a must read article! Remember, we don’t know what we don’t know!
Money is
often a scary issue for many to deal with, especially for those who have never
worked with it in detail before. Investing
for the future can be even scarier. Still,
people at every age and certainly those preparing to retire need to know the
basics of investing to insure their financial freedom and future. For the do-it-yourselfer, developing an
understanding of the breadth and extent of asset classes or investment types,
as well as the various strategies to exploit them, can be a daunting task. And, for those who employ investment
management professionals to help, developing an understanding of the
differences between them can be challenging as well.
As readers of my newsletters well know, wealth management is
the ultimate goal of all that we do at Hoffman, White and Kaelber. Yes, we promote our services; yet, you will find that we always
seek to present thought provoking topics that are relevant to our wide audience.
This
month’s newsletter will discuss the various types of investment manager
specialties, as well as the concepts of diversification and asset
allocation. So, fasten your seatbelts
and get ready to learn one of the more useful lessons to successful investing. And, as we consider ourselves expert asset
allocators, be sure to look over how we’ve performed at the end of this month’s
letter. You might find the results surprisingly
good!
Investment Manager Specialties
From the book Money Managers & Mutual Funds: “Money managers have served pharaohs, kings, emperors, popes, and
merchant traders - and now are available to average investors. One of the most
significant modern developments in money management was the creation of the
"Prudent Man Rule" in 1830, setting a standard that managers
must conduct themselves honestly and discreetly and carefully… Mutual
funds were born in
I’m often surprised to find that a number of investors are
unaware that money managers can be hired in a number of ways. Yet, of greater concern, many investors don’t
realize that there can be significant differences in the investing styles, as
well as, the risk and return profiles from manager to manager.
As opposed to mutual fund, hedge fund or other types of
pooled investor-manager relationships, some relationships allow for managing one’s
investments in one’s own individual or separate account. It is believed that, one of the primary advantages
of this type of arrangement is the ability to manage an investment portfolio for the maximum
tax efficiency, but I think this understates the bigger picture. This arrangement
offers the highest level of personal and fiduciary service available to most
investor clients. Yet, as you might
expect, a relationship like this usually requires a much higher minimum
investment versus what you might expect from the average mutual fund.
What
should be of greater importance to an investor is an understanding of the
differences between the various types of investment managers and their
strategies - because all are not the same! In fact, one’s expectations for investment
returns, volatility, and risk can vary
enormously from manager to manager.
While
I had originally planned to discuss various types of mutual fund, hedge fund
and other alternative investment strategies, as well as their potential risk
profiles, I think I’ll save that for a later article. What may be more important to convey is that most investment managers use a unique methodology to decide which
shares, bonds, commodities or other assets to buy and sell. While there are as many approaches to
investment management as there are managers, most managers tend to fall into
one of several categories or styles. Why
is this?
According to the Frank Russell Company: “The concept of [investment] style originated in the
The key
points to be made here are that, since the 1970s, most investment managers have
migrated towards specialization and, of this group, the odds are that any single manager will have a bias towards
one style and their performance may suffer when that investment style is out of
favor. Additionally, not only might
performance suffer when an investment style is out of favor, but the magnitude
and duration of the suffering can vary significantly also. Even in the hedge fund world, where one or
more specialized strategies may have been blended or combined in some unique
way, much specialization occurs in that arena too.
Enter the era of professional asset allocators.
But before we go there, I want to distinguish the
differences between diversification and asset allocation. You might be surprised how these two words
are often confused – even by financial professionals.
Diversification
How
many times have you heard the saying: “Don't
put all of your eggs in one basket”?
This age old saying has been passed down from generation to generation to
generation… Yet, in the investment
world, diversification can be achieved in a number of ways. Let’s look at how this may mean different
things to different people:
Diversification within a specific investment type. For this scenario, let’s consider junk bonds
for example. Junk bonds are also known
as high yield bonds. For our example,
let’s say that junk bonds are a specific investment type within the asset class
comprising fixed income securities.
Junk
bonds are, most commonly, corporate bonds having a high yield and high
risk. This is an oversimplified
definition. They are bonds issued by
companies that carry a speculative credit rating. To compensate for this risk, junk bonds will
generally pay a higher interest rate yield than their investment grade
brethren. The most substantial risk with
junk bonds, is that the issuer could default (not fulfill) on its payments of
interest, principal or both. When a bond
goes into default, significant loss in value of that investment is almost
certain.
With
this being the case, an average investor buying individual junk bonds might be in
for quite a gamble. Yet in a portfolio
of 25 or more junk bonds, if one bond drops in value for reasons specific to
that bond, the effect on the whole portfolio will be limited. In this case, diversification lessened the
impact of default risk within this narrow classification of bond funds.
Diversification within a specific
class of assets. For this scenario, let’s consider stock funds
as an asset class. Not all stock funds
are alike. In this category, funds
invested in stocks of established companies with under-valued stock prices are considered
value style funds. Investment managers with
a value style bias are bargain hunters anticipating that, once the under-valued
stocks they’ve discovered become more noticed, the stock prices will rise
toward their expected market value.
On the other hand, investment managers of growth style
funds select stocks of companies with fast growing earnings. These managers anticipate that, as long as the
companies they’ve identified continue to exhibit above-average earnings growth,
the stock prices will grow above-average as well.
Additionally, one fund may invest in stocks of large
When combined into a portfolio, these various "styles" of stock funds
– which typically react differently to economic and market changes – may work
together to lower your overall risk.
Diversification amongst asset classes. For this last scenario, diversification simply
means dividing your investment dollars between different types of investments –
like stocks, bonds, real estate and commodities, to name a few – to lower your
risk. In this case, diversification can
work as a safety net when investor sentiment or economic events favor one or
more asset classes to the detriment of others. A short-term setback or negative market change
in one investment option may be offset by a positive gain in another.
Herein
lays the groundwork for why asset allocation is an important concept for
investors seeking to insure their financial freedom and future. This brings us to our next discussion point...asset
allocation.
Asset Allocation
The term asset allocation means different things to
different people. The goal of some asset allocation
funds is to maintain a static asset allocation mix, while others vary the asset
allocation mix as market opportunities change.
Although the trend of thought, by most professionals studying this
concept, is that varying the mix will produce better year-over-year results for
investors.
Some investors equate asset allocation with short-term
market timing – which, by many, is considered very risky. Others view it as a dynamic process of
identifying longer-term valuation discrepancies between asset classes and
taking advantage of these to either increase return without increasing risk, or
to manage risk without sacrificing return. Some use technical analysis (models of price
and volume data) to time shifts from one asset class to another – this type of
analysis is often used by the market-timers. Others combine numerical analysis and
qualitative judgment (making comparisons based on different qualities). Finally, like I mentioned above, some take a
very long-term view of asset allocation and advise static allocations to
various asset classes based on investor risk tolerance. There is no single “best” way to allocate
assets. Yet, we don’t advocate
short-term market timing or sole reliance on technical analysis.
Here are some of the more common asset allocation
strategies out in the marketplace today:
Multi
Strategy Approach: This approach focuses on diversifying by
employing various strategies simultaneously to realize short- and long-term
gains. Others may include systems
trading such as trend following and various diversified technical strategies. In this style, the manager will seek to
overweight or underweight different strategies to best capitalize on current
investment opportunities.
Opportunistic
Approach: Here, the investment theme changes from
strategy to strategy as opportunities arise to profit from events such as initial
public offerings, sudden price changes caused by an interim earnings
disappointment, hostile bids, and other event-driven opportunities. This type of manager looks for special
situations, or opportunities, may utilize several investing styles at a given
time and is not restricted to any particular investment approach or asset
class.
Macro
Approach: This group, often found in the hedge fund
world, aims to profit from changes in global economies, typically brought about
by shifts in government policy. They usually participate in all major markets (equities,
bonds, currencies and commodities), often rotating their investment exposure
based upon how they perceive the policy shifts will create an impact. They sometimes utilize hedging techniques,
but leveraged directional bets tend to make the largest impact on their performance.
As such, because they often use leverage
and derivatives to accentuate the impact of market moves, you can expect your
investment risk to be very high.
Fund of
Funds Approach: This style mixes and matches mutual funds and
or other pooled investment vehicles. This
blending of different strategies and asset classes aims to provide a more
stable long-term investment return than any of the individual funds. Returns, risk, and volatility can be controlled
by the mix of underlying strategies and funds. Capital preservation is generally an important
consideration. Volatility depends on the
mix and ratio of strategies employed and, more often than not, the risks are
low to moderate.
Multi Strategy Fund
of Exchange Traded Index Funds Approach: This approach not only offers an efficient
way to invest in whole baskets of stocks, bonds and other asset classes, both
in the US and abroad, it makes managing risks an easier task. Portfolios are adjusted to take advantage of
relative attractiveness among industry sectors and economic factors that may
influence stock, bond and other markets.
Capital preservation is the primary priority and much emphasis is placed
on properly diversifying portfolios and coordinating risks. Expect your investment risk to be low. Hey!
Wait a minute! That’s what we do
here at our firm…
Concluding
Thoughts
Professional
asset allocation managers take the burden off investors by incorporating the
basics of smart investing (asset allocation, diversification and reallocation)
into a single relationship. Using a multi-style approach that incorporates
complementary investment styles ensures investors are not exposed to 'style
cycles' as different investment approaches or styles move in and out of favor.
Hoffman, White & Kaelber Financial Services Investment
Performance Update
The
Fourth-quarter
GDP growth came in at only 1.1%, the slowest growth rate in three years, far
below expectations of 3.0% that most economists had looked for. While it was widely expected that Fed Chairman
Greenspan, in his last day on the job, was going to raise the federal funds
rate by another 25 basis points to 4.50%, the markets began to believe that the
Fed might pause after that move. US
stock markets rallied as a result.
But this
past week, the household survey showed the unemployment rate dropping to 4.7%,
from 4.9%, hitting its lowest level since July 2001. Alongside that drop in unemployment, average
hourly earnings rose 0.4%, taking its year-over-year advance to 3.3%, the
strongest gain since February 2003. The
increase in earnings, combined with stronger employment, suggests that wage
income began 2006 on a strong note. If
this is so, the consumer may not be done buying and the potential for wage
inflation exists.
After this
news, economists began to assess, with assumed robust growth prospects and
hints of inflation that the Fed, under new Chairman Bernanke, will need to raise interest rates to 4.75%, at the end of
March and, perhaps, beyond. Sensing the
risk that the Fed will have to do more rather than less, the markets have begun
to give back January gains.
Things
are already stacking up to be an interesting year…
Our
performance continues on a positive note!
For the month ended January 31, 2006, our one-month performance is up 2.28%,
our rolling twelve month return is up 12.11%, and our average annualized return
since inception is up 10.38%. We are one
month shy of having a full three year performance record! Our since inception risk profile remains very
conservative at +/- 5.58% and our Sharpe Ratio (reward for risk taken) is an
enviable 1.50. For more performance
information, please see our web site for details.
Is a comfortable retirement or preservation of wealth important to
you?
Want better long-term results from your investments?
Choose Us As Your Investment Manager!
Research us on the web at www.hwkfs.com