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Classic strategy in strange times

By Greg Paeth

Ebola. ISIS. Ukraine. Falling oil prices. Dow up 274 on Wednesday. Down 334 Thursday. Contentious negative U.S. election campaigns. Historically low interest rates.

In the fall of 2014, you don’t have to have money invested in the market to be on edge. But if you have any wealth to protect, you almost certainly are.

Which means phones have been ringing more frequently at investment firms as clients look for assurance that the primary similarity between 1929 and 2014 … is merely that both designate a calendar year.

shutterstock_138077258In October, as national and international news created seismic jitters in stability-loving financial markets, wealth managers and investment advisors from across Kentucky stressed to clients and anyone else who would listen that they should take collective deep breathes and ride out what they’re describing as a market “correction.”

That is Wall Street speak for: “Don’t panic, but your portfolio just took a hit.”

Although today’s conditions are not “normal” – or counter-intuitively maybe even because they aren’t – advisers are re-emphasizing the investment fundamentals that for generations have proven to create affluence, if not wealth, for millions of Americans who had the discipline to invest regularly and focus on financial goals that may be 30 years in the future.

That’s not to say that a conservative commonwealth’s finance professionals are oblivious to some new – or at least newly tweaked – investment products that have emerged recently or increased in appeal during the last year. But game changers they’re not. No one has re-invented the wheel, created a short path to spectacular wealth or found a can’t-miss strategy for someone who started retirement planning on their 60th birthday.

Over and over again, finance industry professionals offer the same kind of advice that well-established firms have been providing for decades: Create a long-term plan with realistic objectives as early as possible, and adhere to it despite the market’s day-to-day or year-to-year fluctuations.

“I am generally of the opinion that there’s really nothing new under the sun, generally, when it comes to the world of investments or finance,” said Michael S. Potapov, a chartered financial analyst at E.S. Barr & Co. in Lexington. “Investing a portion of your income – being disciplined – those things don’t change.

“There might be some great marketing budgets behind certain exciting products,” Potapov said, “but I don’t see them really as anything new. It’s just a nice new wrapper (for a product that’s been available).”

True innovation occurs more in process than product, according to Potapov: “I quote (former Federal Reserve Chairman) Paul Volcker, who says that the most useful invention in financial services has been the ATM.”

Focus on quality and avoid big mistakes

“Some investors have their own ideas and want to call their own shots, but generally most of them want to have a discussion about the big picture – and everybody is a lot more thoughtful today about asset allocation,” said Jim Allen, president, chairman and CEO of Hilliard Lyons, an investment firm that traces its Louisville roots to 1854 and now has some 70 offices in a dozen states.

“Be calm. Be longer term in your thinking, focus on quality and avoid big mistakes,” Allen said, offering the kind of time-tested investment advice that the founders might have provided when the company opened its doors 160 years ago.

Investors come in more varieties than investments do.

“There are two ways to invest: The aspirational ‘swing for the fences,’ and then there’s ‘what do I need to get out of this money? What’s my required rate of return?’” said Daniel Poposki, vice president and senior portfolio manager for the Investment Advisors Division of Fifth Third Bank. “We try to be more needs based. With our clients, they’re certainly not looking for us to take some speculative bets on something.”

Rather, the typical customer’s expectation is, “Let’s be consistent. Let’s be rational,” Poposki said. “And the nature of the markets – going up and down – that’s part of the deal.”

Steve Frank, senior vice president of investments for Wells Fargo Advisors in Cincinnati, said he wants his clients to understand why they’re investing and how much risk might be required to reach a specific goal.

“Unfortunately, too many people invest without a well-considered plan and without a good understanding of what kind of risk taker they truly are,” Frank said. “Too often people let their fear overwhelm a plan and become caught up in the emotion of the latest headline or the mood of the crowd. That should always be resisted.

“I have found that when you can’t wait another minute to place a buy or a sell order because you feel that you are either about to miss out or get clobbered, that you are invariably making a mistake,” he said.

Pursue value buys rather than trends

Andy D. Waters, president and CEO of Lexington-based Community Trust and Investment Co., was in agreement about the critical importance of using time-tested methods to determine investment quality.

[pullquote_left]“Be calm. Be longer term in your thinking, focus on quality and avoid big mistakes.” — Jim Allen, president, chairman and CEO of Hilliard Lyons[/pullquote_left]

“Sound investment advice is not ‘trendy,’ ” Waters said when asked about new products or strategies that had emerged this year. “It’s an age-old process of risk/return evaluation. Advice in light of the ‘Great Recession’ involves setting the appropriate investment expectations when evaluating investment alternatives.”

Community Trust constantly searches for “value investments, or buying quality on sale,” he said. And once the company finds what appears to be a value investment, Community Trust scrutinizes the security to ensure that it’s as good as it looks.

Some categories of investment are, indeed, deemed “value” buys of late. Like a couple of other investment professionals interviewed for this story, Waters said the broad category of retail stocks – also sometimes referred to as the “consumer discretionary” sector – “…appear cheap right now, and energy (sector stock) is starting to get that way.”

Mark Wilden, who heads the four-person group in the Lexington branch of Merrill Lynch, agreed that consumer discretionary stocks are attractive now because of falling oil prices, which means consumers have more dollars to spend. Cheaper prices for gas are “like a tax cut to the average consumer,” said Wilden, who mentioned Nike and Disney as good examples of the consumer discretionary category. He stressed, however, that he was not recommending either stock.

Fifth Third’s Poposki mentioned Nike, Disney and Starbucks as prime examples of consumer discretionary stocks and, like Wilden, emphasized that he wasn’t recommending those companies.

“We do like technology. We do like the consumer,” Poposki said. “The balance sheet of the consumer – that’s as good as it’s been for over a decade. We like the consumer stocks – both the staple (products) side (Procter & Gamble, for example) and the discretionary side.”

A reason for optimism about consumer spending, Poposki said, is a recent survey showing that the typical employee was no longer worried about losing a job. Instead, the biggest concern had become whether that worker would receive a raise, he said.

Low interest rates generate ideas

Although the historic low interest rates of the past several years can be a boon to people who are buying a home or a business or refinancing debt, they can be anathema to those who are trying to lock in a decent return through savings accounts, CDs or bonds.

shutterstock_86257369“The biggest change in the industry today is that we’re seeing a lot of alternative funds that are out there – unconstrained bond funds because interest rates are so low,” Wilden said. “There are bond funds today with managers that actually will establish what’s called negative duration or negative interest rate risk: where if interest rates rise, your principal actually goes up rather than coming down.”

As the name indicates, the unconstrained bond funds give managers plenty of latitude in what bonds they invest in – virtually anything that’s out there – as well as the duration of the investment. Investors.com reported recently that about $46 billion moved into these funds last year and that they have attracted another $33 billion in the first nine months of 2014.

Edward A. Hely, a wealth management advisor in the Paducah office of the Northwestern Mutual Financial Network, said his company has applied for a patent for a deferred income annuity that can grow through “potential dividends.”

“Deferred income annuities have been around for a while,” Hely said. “They allow you to put a lump sum premium with an insurance company and have a guaranteed lifetime income starting up to 10 years later. With our low-interest-rate environment, the income guarantees (for annuities) have shrunk.

“Our new income annuity has the potential to pay dividends. Whenever a dividend is paid, the client can choose to leave it in the contract and grow their future guaranteed income,” he said. “Dividends are never guaranteed, but Northwestern Mutual has paid them every year since 1872 to its life insurance policy owners.”

New options but no quick fixes

Like others interviewed for this story, Hely said there are no quick fixes for people who haven’t planned for
the future.

“Unfortunately, we do see some individuals who have put off planning for retirement until they are in their 50s, and there are not any magic bullets,” Hely said. “These people usually have to work longer, cut current spending to save more or downsize their retirement dreams. That is why we try to encourage our clients to start a financial plan in their 20s and 30s.”

While Potapov makes clear his skepticism about many new products or old products with new names, he does note that one recent trend is the growth of the ETF (exchange traded funds) market, which “offers people the opportunity to buy anything from Indian small caps to just broad market exposure, whether it’s an equity or a fixed-income (product) or something else. Those have certainly been attracting lots of assets. Some of them are performing well; others are not performing well. So it’s hard to say with one investment in an ETF that (a client will) achieve investment nirvana.”

In the industry, ETFs often are compared to mutual funds but have the advantage of being traded on exchanges like a stock, so investors can move in and out of an ETF quickly.

The boom in U.S. natural gas production from the use of hydraulic fracturing, or fracking, has fueled interest in master limited partnerships, according to Michael Weiner, a chartered financial analyst and chief investment officer of Unified Trust in Lexington. Also sold on public exchanges, these partnerships are required by law to derive some 90 percent of their cash flow from investments in natural resources, real estate and commodities.

Poposki said Fifth Third has made some investments in master limited partnerships.

“We’ve done a little bit of that – up to 5 percent of a portfolio. We look at it as more of an opportunistic allocation, meaning it’s not something that we may be in forever, but we feel like it’s a good opportunity over the last couple of years. They basically pay you 4.5 or 5 percent yield.”

Business news publication Barron’s reported in its annual MLP Roundtable in February that their average return was 5.7 percent. MLPs outperformed the S&P 500 from 2000 until 2011, Barron’s said, but failed to do so for the last two years.

Although acknowledging that the partnerships have been attracting investors, Weiner said Unified Trust doesn’t invest in MLPs and emphasized that his firm pays far more attention to high-quality companies that pay dividends, which is a key element of what he called a “lower volatility metric.”

“Thirty or 40 years ago this was known as ‘blue chip investing,’ ” Weiner said, “but some people want to be (invested) in pharmaceutical or biotech companies with a couple of drugs in blind trials (a late stage of FDA review). If they work, you make a fortune. If they fail, you lose all your money. A lot of investors prefer that (and) view that as a good way to invest in the stock market as opposed to (buying stock in) something like Coca-Cola or Exxon, which point to point go more slowly, but the dividends double (invested assets) in six or seven years,” he said. “We’re starting to see our wealthy clients say that makes sense; we may see a renaissance (in the blue chip approach).”

Greg Paeth is a correspondent for The Lane Report. He can be reached at [email protected]