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- Tuesday, January 06, 2009
FIM Group Mailbox
Posted September 12, 2008
The barrage of negative economic headlines and weak short–term investment performance has generated an understandable increase in client concerns. Here is a typical interaction that covers some of the more frequent questions we have been answering of late. As always, please feel free to call any of our team members should you have concerns about your portfolio.
Q.) I understand that most investment markets are down this year and that other money managers, including legends like Warren Buffett (Berkshire Hathaway) and Bill Miller (Legg Mason), are also suffering. I thought that FIM Group's active management would better navigate my portfolio through these difficult markets. Why is my portfolio down this year?
Simply put, our portfolios are down because we have chosen to stay invested in our diversified portfolio of securities at a time when fear has become the dominant factor in many markets. This fear has forced some investors to abandon their long–term plans and run for the exits.
Panic selling has negatively impacted transaction prices, which in turn are reflected in the daily market values of our portfolio values. In particular, we own companies not only in the United States, where market sentiment and performance is weak so far this year, but also abroad, where in most cases sentiment and performance has been even worse.
Q.) If sentiment is this lousy, why have you stayed so fully invested?
Trying to predict short–term twists and turns in market sentiment is virtually impossible. We spend the majority of our time analyzing shifts in a company's fundamental outlook and comparing that to current market prices. The cheaper the market price versus our estimate of fundamental value, the bigger the bargain and the more we want to own it. Our focus on fundamental value essentially boils down to an analysis of the stability and growth potential of a company's future cash flow. We analyze many factors, including competitive position, industry growth potential and financial strength. Presently, despite the current slowdown phase in the global macroeconomy, we feel very good about the fundamental strength of the majority of our portfolio investments. As such, our portfolios are nearly fully invested, as we firmly believe that over time market sentiment will normalize, and prices will eventually reflect our fundamental value estimates.
Q.) Economic headlines seem to be getting worse. When is the economy going to get better?
Economic data, by its nature, is backwardlooking. We can analyze the past and make guesses about the future, but that is all they are – guesses. The good news is that recessions typically last less than a year, and most of the data we watch (including employment, industrial production, personal income and retail sales) seem to have turned south at the beginning of this year. Therefore, we are likely already more than halfway through this recession (even though any recession will probably not be officially announced until the end of the year). Household debt and home inventories remain two indicators of many we are watching for signs of a recovery. When either begins to improve, we would expect market sentiment to become significantly less depressed.
Q.) What are you doing to ultimately recover these losses and generate gains for my portfolio?
We constantly test each security in our portfolio for changes in its fundamental value. When we find that the long–term outlook no longer justifies our position, we sell (in some cases capturing a tax loss for taxable accounts). We are adding to our highest conviction holdings as other investors are forced to sell them. To do so, in some cases we are selling holdings judged to offer less risk–adjusted opportunity. These decisions are made as part of our team's daily review of portfolio positions. During times of fear like this it should be understood that portfolio changes may occur more frequently as we squeeze out lower–conviction holdings with higher–conviction ones. We are placing a greater emphasis on stocks with sustainable, above–market dividend yields. We believe that if we remain in an economic downturn, and if investor sentiment remains poor, solid dividend payers will be very important for our total return objectives.
Q.) Why not just sell my stocks and bonds and hold cash until things stabilize a bit?
Panic selling has negatively impacted transaction prices, which in turn are reflected in the daily market values of our portfolio values. In particular, we own companies not only in the United States, where market sentiment and performance is weak so far this year, but also abroad, where in most cases sentiment and performance has been even worse.
Q.) If sentiment is this lousy, why have you stayed so fully invested?
Trying to predict short–term twists and turns in market sentiment is virtually impossible. We spend the majority of our time analyzing shifts in a company's fundamental outlook and comparing that to current market prices. The cheaper the market price versus our estimate of fundamental value, the bigger the bargain and the more we want to own it. Our focus on fundamental value essentially boils down to an analysis of the stability and growth potential of a company's future cash flow. We analyze many factors, including competitive position, industry growth potential and financial strength. Presently, despite the current slowdown phase in the global macroeconomy, we feel very good about the fundamental strength of the majority of our portfolio investments. As such, our portfolios are nearly fully invested, as we firmly believe that over time market sentiment will normalize, and prices will eventually reflect our fundamental value estimates.
Q.) Economic headlines seem to be getting worse. When is the economy going to get better?
Economic data, by its nature, is backwardlooking. We can analyze the past and make guesses about the future, but that is all they are – guesses. The good news is that recessions typically last less than a year, and most of the data we watch (including employment, industrial production, personal income and retail sales) seem to have turned south at the beginning of this year. Therefore, we are likely already more than halfway through this recession (even though any recession will probably not be officially announced until the end of the year). Household debt and home inventories remain two indicators of many we are watching for signs of a recovery. When either begins to improve, we would expect market sentiment to become significantly less depressed.
Q.) What are you doing to ultimately recover these losses and generate gains for my portfolio?
We constantly test each security in our portfolio for changes in its fundamental value. When we find that the long–term outlook no longer justifies our position, we sell (in some cases capturing a tax loss for taxable accounts). We are adding to our highest conviction holdings as other investors are forced to sell them. To do so, in some cases we are selling holdings judged to offer less risk–adjusted opportunity. These decisions are made as part of our team's daily review of portfolio positions. During times of fear like this it should be understood that portfolio changes may occur more frequently as we squeeze out lower–conviction holdings with higher–conviction ones. We are placing a greater emphasis on stocks with sustainable, above–market dividend yields. We believe that if we remain in an economic downturn, and if investor sentiment remains poor, solid dividend payers will be very important for our total return objectives.
Q.) Why not just sell my stocks and bonds and hold cash until things stabilize a bit?
After seeing our portfolios drop in market value so far this year, the natural urge to join the herd and run to the sidelines is understandable. Our experience and training, however, guides us to keep a long–term perspective and stay with our portfolio investments when the fundamentals remain sound. After all, if the fundamentals are sound, why sell if you don't have to? Most of us wouldn't sell our homes or our businesses when prices are as visibly distressed as they are now, so why do so with our stock and bond portfolios?
Q.) Why are you investing in financial and consumer discretionary stocks when it is so clear that we are in a recession?
We believe that the financial sector has been indiscriminately sold off. This has occurred despite the fact that many financial sub–sectors, including U.S. and foreign insurance companies and investment management companies, have very little direct exposure to the problems plaguing U.S. mortgage lenders and investment banks. Where we do have U.S. bank exposure, we have invested primarily in corporate debt and preferred stock holdings, whose prices we believe already reflect a worst–case scenario. On the consumer discretionary front, we are attracted by not only historically low valuations, but as mentioned in last month's Investment Committee brief, the sector's historically low weighting in the overall market. We are not discouraged by what will likely be tough sledding in the near–term for earnings growth in this area, but instead look at how current prices compare to the long–term cash–flow generation prospects for these companies. We believe that now is the time to snap up great franchises in the consumer discretionary space at tremendous discounts to long–term fundamental value.
Q.) How do you plan to take advantage of fear in the market when I am already nearly fully invested?
When cash levels are low (as they are in many of our portfolios today), we take more time to rank each security held in our portfolios by level of conviction. In taxable accounts, this ranking process includes a careful consideration of both realized and unrealized gains and losses. To make room for our highest conviction buy ideas, we sell our lower conviction investments. Where possible, we harvest tax losses in taxable accounts.
Q.) Some of my investments are now trading at just a fraction of my average cost. How will I ever recoup this value?
For our highest conviction securities, we are reducing average cost by adding to our positions opportunistically. In a handful of cases, we acknowledge that the investment does not merit further capital and either sell immediately or hold (when we assess further downside risk to be minimal) until we can achieve a better selling price. As mentioned above, we believe that the majority of our holdings trade at a significant discount to their fundamental values and will recover their lost market value as sentiment improves. In addition, our shift to greater dividend payers will also enhance total return over time.
Q.) Anything else to convince me that your team is doing the right things for the long–term protection and growth of my money?
A very important concept to get across is that during times like this we want to avoid being forced sellers. Pressures to join the herd and abandon long–term plans naturally grow during times of fear like this and are compounded by daily media reminders of how "bad things are" and daily portfolio appraisals that reflect the sentiment in the market. Our investment team is working hard to not only avoid the behavior of the herd, but also to hone in on great opportunities presented by the stampede. As noted above, we feel very confident that the fundamental value in our portfolio companies ultimately be recognized as the market sentiment reverts to more normal levels. In the meantime, we have shifted to a greater emphasis on solid dividend–paying investments that will provide real cash flow for our portfolios. Each member of our team invests in the same strategies right alongside our clients, and although we, too, are unhappy about this year's performance so far, we feel very confident that the actions we are taking today will bear fruit for our portfolios in the future.
Performance results reflect the deduction of advisory fees. Portfolios managed by the firm can experience losses, as well as profits. Therefore, the figures shown should not be considered as a guarantee of future gains or as a limitation on potential loss. The investment advisory fees are disclosed in Part II of Form ADV. The accounts used in these calculations were entered into the calculations when the account value reached $150,000. The account stayed in the calculations until the account value dropped below $125,000. Accounts reentered calculations when the value again reached $150,000. Performance returns were time-weighted monthly, and all trading commissions and management fees were deducted when calculating the returns. All portfolios had dividends and other earnings reinvested. The portfolios selected were categorized by objective based upon the risk tolerance category expressed by a client. The portfolios include all discretionary accounts. The accounts used also did not include unmanaged assets, annuities or limited partnerships in the calculations. Clients having portfolios containing tax, client imposed or other restrictions would have had higher or lower returns than those expressed above. The performance data shown above represents the past performance of the firm’s different risk tolerances. These figures have not been audited or otherwise reviewed by an accountant or third party. Also, this data presentation does not conform to the Association for Investment Management and Research Performance Presentation Standards. During the periods covered, other advisory firms have joined FIM Group. The performance of accounts brought under FIM Group’s management are included in FIM Group performance beginning in the first full quarter after which those portfolios have been fully converted to FIM Group selected securities. Any questions regarding the compilation or composition of this data may be brought to the attention of FIM Group at 800-632-5528, 888-243-8220, or 888-33-TRUST. Portfolios are managed by the FIM Group Portfolio Management Team. Paul Sutherland has been the Chief Investment Officer and Lead Portfolio Manager since 1984. FIM Group Portfolios represents a mix of global equities, global fixed income, and cash. The main difference between the portfolios can be attributed to the distribution of holdings within a portfolio based on risk tolerance.
Performance data quoted represents past performance. Past performance does not guarantee future results. All performance assumes reinvestment of dividends and capital gains. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Performance data current to the most recent month-end may be obtained by calling: 231.929.4500.
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