Well, And Wisely, Done

Many of my clients and regular readers are already aware that my father, John Beule, is nearing the end of his long life journey.

As I look back on the past 4 ½ years – the period of his final decline – I am amazed by how much I have learned by being with him as he made his way down his path.

Everybody’s circumstances are, of course, different. Nothing happens the same way twice. Yet I am convinced that much of what I have learned through the process of caring for my parents over the past several years is generally applicable. And while some of my experiences confirmed what I thought I knew, other aspects surprised me.

As we all try to envision our lives in the future, I believe it helps to have had some concrete experiences to shape our thinking. I would therefore like to share some of what I have learned (or had confirmed) with my readers. I hope it will both help and comfort readers as they consider not only their own but also their parents’ and children’s lives and future plans.

❧

 

The Greek Debt Crisis and Griffin Black Portfolios

The recent sell-off in worldwide equity markets occasioned by the Greek debt crisis has no doubt been of concern to many of you. Here are some things that you might want to know and consider.

First, the recent developments in Greece have had no immediate impact on Griffin Black’s tactical portfolio allocations. The fact is that this sovereign debt crisis reflects many of the risks and uncertainties we have been discussing since the global financial crisis began to unfold in the second half of 2008. Our ongoing assessment of those risks caused us to adopt a relatively defensive (underweight) position in equities (and equity risk) in our balanced portfolios some time ago.

The root of the systemic, global risk that has found a current flash point in Greece is an excessive build-up of debt (both by governments and households), compounded by unsustainable current and projected future levels of spending relative to revenues. We have written about the likely consequences of this situation in the US as (1) sub-par economic recovery and earnings growth, (2) higher interest rates (bad for growth as well as for stock market P/E multiples), (3) the return of inflation down the road, and (4) a depreciating US dollar relative to emerging markets currencies, which are generally in much better fiscal shape than the US/Europe/UK/Japan. Greece’s fiscal and economic situation is much worse than the US’s, but without a credible plan for debt and deficit reduction in the US it might foreshadow what we can expect here as well.

Despite all the (currently) bad news, we do not (yet) think that the probabilities we assigned to the various economic scenarios used to guide our asset allocations have changed materially, and that is why our portfolio allocations have not changed. In fact, one could argue that what is going on in Greece is a good thing in that it may help encourage the US and other countries to act more aggressively to implement credible debt-reduction policies in order to avoid Greece’s fate. So while the near-term potential for a flight to quality or a spike in risk aversion remains high, we have not (yet) changed our longer-term (five-year) assessment of expected equity returns.

On the fixed income side, we do not have any direct tactical exposure to European sovereign debt. Both of our primary fixed income managers (PIMCO and Loomis Sayles) have said they are not/were not invested in any of the PIIGS’ (Portugal, Ireland, Italy, Greece, and Spain) government debt. In terms of currencies, Chris Dialynas recently said that PIMCO is positioned for more euro weakness as a result of “the eurozone’s fiscal risk premium” and Dan Fuss has minimal-to-zero euro exposure in his fund. If we do see a short-term flight-to-quality trade (i.e., money going into US Treasuries/the dollar from more volatile/riskier asset classes), our tactical position in emerging-markets local-currency bonds will almost surely take a short-term hit. Longer-term, however, the relatively strong economic fundamentals for emerging markets relative to developed economies continues to support the tactical thesis for owning emerging markets local debt.

From a contrarian perspective, extreme events and the fear generated by them can create great investment opportunities for fundamental investors with a longer time horizon willing to absorb shorter-term volatility and downside risk. Some of our fund managers, for example, tell us they are looking at potential stock-picking opportunities, particularly in Spain.

Finally, we continue to keep abreast of developments in Greece and the PIIGS, continue to read analyses and talk to fund managers to get their views and insights, and continue to re-assess our risk exposures and portfolio positioning in the variety of scenarios that we think are likely to play out, as well as in lower-probability scenarios that would have very large negative outcomes. As always, we will apply our informed judgment in balancing the wide range of potential outcomes against each portfolio’s shorter-term risk threshold and longer-term return objective.

 

Why It’s So Hard To Save (Part I)

According to the Wall Street Journal, Americans’ personal saving rate jumped to 6.9% in May, up from 5.6% in April, and way up from the negative saving rate of just a couple years ago. Why? The simple answer is probably that we are finally scared. There is a whole generation of Americans – perhaps even two or three – who have learned to spend without considering whether or not they could afford to. And despite the seemingly quaint echoes from our Depression-era parents and grandparents (“Waste not, want not,” “Save for a rainy day”), many of us seem to have convinced ourselves that we had the right to spend as much as we wanted for as long as we wanted without any serious long-term negative consequences.

Now, at least some Americans have become afraid that we are subject to the timeless laws of economics after all. (Our governments seem not yet to have begun to become afraid, but that’s the topic of another post.) What are those laws, and even more importantly, why were they so easy to ignore for so long?

I trust that any professional economists reading this post will grant me a certain amount of literary license in portraying the three primary laws of economics as follows:

1. The desire for economic goods is endless. However much you have, you have the capacity to want more.
2. If you spend more than you have (in earnings and savings), the difference must come from someone else. You can borrow it, get it from other people illegally (i.e., steal it), or get it from other people legally (e.g., in the form of government transfers, handouts, bailouts, etc.). In the end, however, someone always pays. (This is the economic equivalent of the Law of Conservation of Matter and Energy.)
3. Each of the spend-more-than-you-have options above has nasty consequences.

• If you borrow it, the time-value-of-money means that you’ll end up paying more for it over time than you have to pay now.

• If you steal it, you risk costly social and legal consequences.

• If you rely on legal (but not economically motivated) receipts, both you and the community you live in pay in the end, but in other and frequently difficult to predict ways.

So what has been going on with us Americans over the past 65 years? Simply stated, we have either forgotten or been talked out of our understanding and acceptance of the negative consequences described in Law #3. As a result, we have inevitably fallen prey to Law #1, regardless of our income level or available resources.

You don’t believe me? Well, let’s take things step by step. Law #1 is actually one of the most difficult to fully understand and accept, because in order to do so we must be aware of our own psychology and vulnerabilities. In fact, many people don’t think it’s a law at all. For example, it is frightfully easy to imagine that if we only made $50,000 more per year (or perhaps $100,000 more) or if we inherited (or won) a large sum of money, all our financial troubles would vanish. We would have what we need, we would have enough, and we would be content. Right?

Yet time and time again we have learned that this simply does not happen. As our income or available resources increase, so do our economic wants and needs – unless there is a countervailing force, internal or external, to prevent it. In other words, unless we learn to self-manage our desires – at whatever level of resources – we will inevitably hit an external constraint. There are no exceptions to this rule. Lottery winners routinely go bankrupt within 2 years of receiving their windfall. Tragically, many end up unhappier than they were before their winnings, because they are left with a sense of guilt and loss that they didn’t previously have.

And which one of us doesn’t remember getting our first paycheck and thinking that if we could increase our take home pay by 50% we could live like kings and would be contented forever? Yet here we are, several decades later, making 200% or 500% more than what we did when we started and still thinking that we are only a raise away from bliss.

Really grokking the fact that each of us needs to learn to live happily within the law of economic limits – and that failing to do so will inevitably lead to unhappiness, disaster, or both – is akin to the realization that one is an alcoholic and is powerless to control one’s own destiny without grace and the support of a higher power. Rather than being a sign of resignation, it is instead a life-affirming and liberating realization. The understanding that our capacity for happiness is self-generated and therefore not subject to the external whims of economic serendipity is an epiphany of the first order.

Why, then, is it so hard to believe that our capacity for joy is endless and that it is not a direct function of the money we make or have? I can’t say I’m sure of the answer, but I suspect that it has to do with the idea that making ourselves responsible for our own happiness would be too painful at some level. If we do that we can no longer blame somebody else for our own inadequacies or the slings and arrows that life throws our way. Giving up the idea that our happiness depends on that shiny new car (or house) means looking within ourselves and coming to terms with what we find there. That is a scary proposition.

One of the more destructive corollaries of Law #1 is that if you have not learned to be happy within your current economic circumstances, it becomes easy to imagine that other people don’t “really need” more than you have. After all, if you are making $50,000 it is the simplest thing in the world to believe that someone making $250,000 a year (which seems to be the government’s new definition of the evil rich) doesn’t really need all that dough. But in truth no one can know such things. Perhaps the individual making that $250,000 is a new surgeon who has $300,000 in medical school debt and because of that investment in education has a reduced period over which to both pay back that debt and reap economic benefits commensurate with his or her contribution to society. The $250,000 looks different from that perspective.

In other words, if Law #1 can be understood in terms of greed, then its corollary is envy.

Does saying this mean that I don’t believe in making or having money? Heaven forbid, no. I think that money is an invention absolutely of the first order. It is tool-making taken to its highest degree. It is useful beyond our wildest imaginations. But in the end it is only that, a tool. And for any tool to be useful there needs to be a human being to wield it, and hopefully one who is self-aware enough to understand the difference between herself and her money, one to use his money thoughtfully and deliberately in order to achieve things that really will enhance his happiness and the quality of his and others’ lives.

At its core, Law #1 is an understanding that each of us must creatively frame our own sense of economic well-being. If we fail to do so, we will never find the happiness we desire. If we fail to do so we will always be at risk of envying others whose external success seduces us into thinking that they have access to something that we do not.

 

Change Before You Have To

Earlier this week Chancellor Angela Merkel of Germany called for efforts to achieve global economic “sustainability.” This is simultaneously predictable, disingenuous, and potentially revolutionary.

The predictable part, of course, is that the Germans – second, I believe, only to the French among industrialized countries – thoroughly hate change. Sicherheit and Ruhe (security and calm) are among the most beloved words in the language. In contrast to us crazy Americans, who seem to put up with the bust phase of boom-and-bust cycles because we get so high on the boom times, the chronically pessimistic Germans have never embraced the headier aspects of economic freedom, preferring instead to stick with a steady-as-you-go strategy. Lovers of Sicherheit and Ruhe eschew change, which tends to involve risk and upheaval.

There’s something to be said for this, of course, especially seen from the perspective of a deep and persistent recession such as the one we find ourselves in now. Even if boom-and-bust cycles come in perfectly symmetrical sine wave form, those of us in finance understand perfectly well that the pain associated with a certain magnitude of loss is significantly greater than the joy associated with the same magnitude of gain. Moreover, because we all have a tendency to ratchet our expectations upward rather than emotionally accept the fact that certain gains may be ephemeral, we routinely position ourselves for emotional loss in additional financial loss during the down cycles of the economy.

That acknowledged, there is also an element of disingenuousness in Ms. Merkel’s comments. For quite a long time now the Germans have achieved economic prosperity in the same way that the Chinese have, i.e., on the backs of the American (and other foreign – but mostly American) consumer. Almost half (49%) of Germany’s economy is based on exports, so when other nations – and particularly the US – catch an economic cold and stop buying, the German economy catches pneumonia, resulting in a disruption of the steady Eddie demand that has supported German economic prosperity since the end of WWII.

Predictably, the Germans don’t like such disruptions and are calling for more global economic Sicherheit and Ruhe. What is disingenuous, however, is the fact that a good part of a potential solution lies within Germany’s power itself, namely, the power to transition their economy into one that includes a more balanced component of domestic demand. Oddly, Ms. Merkel purports to be doing this, “Germany has made an enormous contribution [to the solution of the world economic crisis], between two fiscal stimulus packages and the automatic stabilizers. With that, Germany is doing its part to overcome this international crisis. … We have done everything we could to prevent our domestic demand from slumping.” Yet what she is referring to here is only the domestic demand that makes up the other 51% of the German economy. She is not talking about achieving the kind of sustainability that would result from a world trade regime in which countries sold to each other about as much as they bought from each other, thereby resulting in true equilibrium.

Ms. Merkel in fact acknowledges that, taken as a whole, the German economy even now continues to export more than it imports. “Our current-account surplus will be around 170 billion euros lower this year than last year. With that we’re making a significant contribution to strengthening global economic activity.” In other words, we’re not going to over-export by as much this year. Aren’t you proud of us? In the long term, however, it isn’t clear that less bad is truly good enough to achieve global economic stability.

Lest anyone think that I don’t have any criticism for my fellow Americans, however, let me move on to my third point, which is true economic sustainability. Just as significant, long-term imbalances between imports and exports (selling and buying, income and outflow) at the national level have been a major contributor to the current economic mess, Americans’ persistent habit of buying more than we can afford is the root cause of the problem at the family level and – in aggregate – at the national level as well. If we as individuals and as a nation understood and corrected this destructive behavior the effects would be truly revolutionary.

They would also be painful in the short term, which is why we Americans are so very reluctant to change our behavior, just as our German friends are reluctant to change theirs. Change is difficult. Yet, unfortunately, avoiding necessary change today usually turns out to require even-more-painful change sometime in the future. The longer we wait to acknowledge that we need to change the longer and more difficult the process of change is going to be. I suspect that I will write much more on this topic in future posts, but for now let me leave you with two pieces of advice from former GE CEO Jack Welch that I’ve always considered to be very wise:

“Accept the world as it is, not as you’d like it to be.”

“Change before you have to.”

 

Bernie’s Legacy

It’s been awhile. Mostly I’ve been on the road, both attending industry conferences and visiting out-of-town clients. Where do I begin…

A couple days ago we finally learned Bernie Madoff’s fate. I think 3 lifetimes is about right for what he did. And though I in no way wish to devalue the horror of what he did to clients directly, the impact of his scheme will almost surely reach far beyond the people with whom he had direct contact.

A case in point: The SEC – the agency that could have and should have uncovered Madoff’s fraud many years ago as a consequence of powers and processes that they already possessed at the time – is now understandably feeling the heat. As a result, the folks at the SEC have proposed a new rule for the Registered Investment Advisor community, viz that investment advisors all be subjected to a an annual “surprise” audit of their clients’ assets – at their own expense of course.

If this sounds like a good idea to you, please keep in mind that this is Washington we’re talking about here. It is supposed to sound good. But in fact it will do nothing to uncover Madoff-type fraud while it will harm all existing clients by increasing the cost of doing business, costs that must and will in turn be recouped from those clients themselves. Let me explain.

The problem with Bernie’s operation was not simply that he operated as an RIA. The problem was that he also simultaneously played two additional roles: he ran a broker-dealer operation and he ran a hedge-fund type investment scheme. All three operations were managed under the same roof (and no, I do not believe that it is remotely possible that Bernie pulled all this off by himself and without the knowledge and cooperation of others in the operation). It is in the interconnectedness of the three operations that lay the risk. Bernie’s RIA business could get away with lying to his clients specifically because – and only because – his broker-dealer and his investment fund mirrored the same lie.

99.99% of RIAs, on the other hand – such as yours truly – have no such control over either the broker-dealer they work with or over the funds they invest in on behalf of clients. Yet without such control they don’t stand a snowball’s chance in you-know-where of getting away with madoffesque mendacity. The broker-dealer/custodian I work with, for example, sends my clients monthly statements that are independent of any reports that I send to them. There is no way I could get away with producing rosied-up reports that showed investment accounts rising by 2% per month if at the same time clients are getting monthly reports from Pershing – the largest asset custodian on the planet, by the way – that tell a different story.

So the SEC’s proposed new rule in fact does nothing to improve the lot of the vast majority of investment advisor clients. The fact is that the SEC already has the power to do surprise audits of advisors who may have control relationships with broker-dealer and other investment entities that would make it easier for them to commit fraud.

The other issue that is in question here is the industry-wide practice of automatically deducting fees from client accounts. This wasn’t a problem for Madoff’s clients – he simply stole all their money and lied to them about it – but our newly hyper-sensitive regulators are now worried that this could become a problem. Here again, however, we have the proverbial tempest in a teapot. The fact that there have been virtually no reported abuses of this practice stems from the fact that there is, in truth, virtually no risk to consumers involved. First, all clients pre-approve such arrangements in writing. Second, advisors are already required by law to give clients notice of each transaction as it occurs. If there is a discrepancy between what a client expects to see and what occurs, it can and should be investigated. Third, independent broker-dealer/custodians again function as honest go-betweens in this regard. In short, the current system is open, straightforward, and efficient – and not in need of further regulation, which would only add complexity and cost to the system.

So why the proposed new rule? One can only conclude that it’s politics as usual.

 

On Marketing and Other Matters

Welcome again to my blog. Here’s where I get to let my hair down and just say it the way it comes to my fingers at the keyboard.

What should I write about first? Well, if this is going to be a stream-of-consciousness opportunity then I might as well begin with an email that I got this morning from my long-time friend Larry. Larry, who is one of the best marketers I’ve ever known, wrote to me with some advice on my new web site. It’s probably really good advice. (Larry’s advice usually is.) Yet it is also problematic advice, and that’s what I want to write about.

Larry’s first nugget of wisdom was: “You do too much negative positioning”. (In other words, don’t say that you’re not a commissioned broker or salesperson.) Larry’s right, of course, to remind me that, generally speaking, nobody cares about what you don’t do in a business. In my defense, however, I would like to say that I struggled with how to handle this particular issue. The fact is that many, many people think that all “financial advisors” operate under the same set of rules. They don’t, of course. And so the question becomes one of how to best communicate the core of the matter. Do you say you are 7-Up, or do you say that you are the Un-cola? Both are true, of course. The difference is a matter of perspective. Will people immediately understand if fiduciary advisors like me try to explain what it is we do do? Or it is a helpful stepping-stone to first say that we are Un-brokers? I simply don’t know, which is why I tried to do both in my initial attempt to explain what Griffin Black is all about. I’m going to keep an open mind on this issue, however. I may well come around to Larry’s way of thinking and not even try to explain that we are truly an alternative to something else that’s out there. If people are looking for an alternative maybe I don’t have to tell them…

Larry’s second suggestion was: “You need to prove it [your claims]. Statistics of your portfolio… Case studies maybe.” Oh Larry, I wish. Here’s the deal. Before the site went live it had to go through my compliance attorney, whose job it basically was to make that there weren’t any numbers in it. Yup, the law essentially forbids Registered Investment Advisors from giving out performance statistics. Heaven forbid that someone out there would take a number from the site and assume that he could also achieve the same result. (“Past performance is not indicative of future results.” Write this on the board 100 times…) So the numbers thing is out.

The question of case studies is more promising – I agree they could be quite helpful – but they are also littered with legal issues. So I didn’t go there right away, though I’m looking at whether and how I might do so eventually. It is absolutely the case that people struggle to truly figure out what it is they get and how it is they benefit from working with a fiduciary advisor. While it’s easy to understand (though perhaps not true) if someone promises to produce safe and high returns on your investment portfolio, it’s really difficult for most of us to imagine how our lives could be made better by sane and reasonable financial decision-making over time. But what if one hadn’t committed to that two-income jumbo mortgage in 2007? What if one had purchased long-term care insurance in one’s 50s, before rates zoomed up? What if one had cut up one’s credit cards 5 (or 10!) years ago and had, instead, built up a $50,000 cash reserve to tide one over through the tough times that looked in 1999 as though they would never arrive? What if, what if, what if… None of these things is about investment returns. And all of them probably would have mattered more than differences in investment returns to one’s feeling of security in the current financial crisis.  So yes, some kind of “case studies” would be helpful and I’m going to work on the idea.

That said, there are two big issues with case studies. The first is that one case is never exactly like another. I can’t tell in advance if what has benefited current clients will benefit a new one. All I can do is to give prospective clients a sense of the kinds of issues that current clients and I have tackled together and what the outcome of those efforts were. I cannot tell in advance exactly where I will be able to add value to a new client nor quantify the potential value of that advice. Not comforting, perhaps, but true.

The second big problem with case studies is that they require that clients be willing participants. Some of my biggest “successes” from an advisory perspective involve advice that I never got my clients to act upon. (So I guess that I can’t call them “successes” after all…) Opportunities that could have been substantial never materialized because – for all kinds of reasons – clients decided not to take advantage of them. Pay some taxes now to avoid paying a far higher tax bill later? Possible, yes, but it is difficult to part with the money now. Restructure one’s business and personal assets to shift risk to the business (where it rightly resides) and away from one’s personal assets? Well, that involves change and paperwork. Re-do the company 401(k) to avoid $10,000 – $15,000 in wasted annual fees? Uh, we like the guy we’re working with and nobody notices the fees anyway. Can I still use these as case studies? May be I’ll have to describe them as the ‘biggest cases that never were’.

Back to Larry, however. His final piece of advice to me was: “How about some testimonials”? Once again, old friend, the lawyers have cut you off at the pass. Written testimonials are absolutely verboten in this business. I certainly hope that my clients are saying good things about me to others in private, but I am absolutely forbidden from compiling what they say and passing it on. Moreover, I’m hardly even allowed to exist on LinkedIn, not to mention letting anybody recommend me there, even in general terms. Take that, say the lawyers. Since there’s the possibility that you could dupe the unsuspecting and unsophisticated into believing that you will actually do for them what current clients say you’ve already done, you can’t let your current clients tell their stories to prospective ones (at least not in a formal way). This is yet another triumph of the power of government regulation to protect the innocent, don’t you think?

Well, that’s probably longer than a first post is supposed to be. But I think I’m getting the hang of this talking back thing. It isn’t going to be bad at all. And thanks, Larry, for your email, your advice, and your friendship.

 

Hello world!

Welcome! I’m new to blogging so it may take me awhile to get started, but I hope you’ll check back to see what’s up here once in a while. Til then…