Back-to-Basics

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There are essentially two core investments instruments. The first is stocks or equities that make investors shareholders or owners of companies, and the second is bonds or fixed income that make investors lenders to companies. Stockholders enable investors to share in the profits of the company whereas bondholders are entitled to a periodic interest payment from the company. Investors, either as stockholders or bondholders, can manage their risk by the number of securities they own and the credit quality of these companies. Individual investments or sector specific investments have more risk whereas widely diversified investment vehicles such as mutual funds have less risk. At the end-of-the day, we believe investors either want to be stockholders or bondholders in what we believe are great companies. Somewhere along the way investing got really complicated for the majority of investors. We try and help investors get exposure to great companies in a sensible and transparent way while minimizing fees and other layers between the investor and their investments. We call it getting back-to-basics.

Minimize Extraneous Fees

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Most investors have no idea what their real cost of ownership is for many investments. The popular mutual fund-of-funds comes to mind to illustrate the potential fees incurred by investors. Initially, the investor may pay an ‘advisory fee’ or a ‘load’ to buy or sell the fund in order to compensate the investment advisor or broker who recommended the purchase of the fund. A fee is paid to the manager of the fund-of-funds who selects which funds to invest in. Another fee is paid to managers of the actual funds inside the fund-of-funds. Each fund at both the fund-of-funds level and the underlying fund level have operational and marketing expenses it may charge. The fund may pay a marketing fee often referred to as a ‘trailer’ to the advisor or broker who sold the fund. The underlying funds have transaction fees in the form of commissions paid to buy or sell the underlying investments in the funds, which may include the purchase of even another fund product with its own layer of fees. The more turnover, i.e. the purchase and sale of securities, in the underlying funds increases the amount of fees paid by the investor. If this sounds complicated then it probably is. All of these fees are a ‘drag’ on the potential return to be enjoyed the investor. A fund-of-funds may be an appropriate solution for a client. We are open-minded. However, simple is better in our view and keep the fees down.

Minimize Turnover

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We try to minimize the amount of turnover that a portfolio will incur. Turnover is the number of times a portfolio is traded relatively to its total value. 100% turnover would mean that the entire portfolio was traded at least once during the year. Many studies have shown that turnover leads to inferior investment performance mostly due to transaction costs (and taxes) even at the institutional level. Some portfolio managers have superior trading skills and generate extraordinary returns through their trading activities. However, this is the exception rather than rule.^ In recent years, many investors have been introduced to the separately management account (SMA). This investment product allows one investment advisor to hire another investment advisor to manage the portfolio of his or her client. While this may make sense for some clients, our general experience is that many investors find themselves having several managers and owning hundreds of securities in tiny amounts relatively to their total portfolio. Sometimes these portfolios have significant amounts of turnover. New clients routinely testify that on a monthly and quarterly basisthey receive pages and pages of statements that make little or no sense to them, and their advisors know very little about the investments in the portfolio. They also have very little access to the person(s) whom they pay to manage their portfolio. Our clients usually want fewer investments, less turnover and want to own companies for the long-term. We help clients simplify their investments and their statements.

^Bauman, W. Scott, Managing Portfolio Turnover: An Empirical Study, Quarterly Journal of Finance and Accounting, Summer 2005.

Simple is Better/Avoid Selling ‘Products’

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In our view simple is better. Wall Street is great at inventing wrappers to put around stocks and bonds, the instruments that make investors owners and lenders to corporations. Probably everyone has brought something home from a store and thought the packaging was either excessive or illogical. We try to avoid products that have too many wrappers.

Some products from Wall Street are great. They are reasonably priced and help investors achieve their objectives. However, many client objectives can be achieved without a ‘product’. When we design investment solutions we generally want a solid rationale to utilize a financial product.