Current Observations

Dear Clients, 

Happy New Year! I often get philosophical and reflective at the end of the year. I think about the past and reflect on the beautiful people I have known and those who are still in my life. I often miss and am saddened by memories of friends and family members who have lost their lives at relatively young ages. I also feel grateful to be alive in these exciting times. Each day seems to evolve and feel like a sort of “stay tuned for what’s next” drama.

When I was young, people would ask me what I wanted to be when I grew up. I would usually say “wise.” (When I was really young, I said, “Tarzan.”) Of course at 15 years old, 30 seemed “old.” Now that I’ve reached the wise age of 61, 90 seems old.

But my inspiration comes from a recent article about an active dancer and yoga teacher who, at 94, has much younger coworkers who say it’s hard to keep up with her. So, I have someone to inspire me to stay active and healthy.

This last week I was reflecting on a different article that got me ornery versus inspired. I decided to vent to my partner Jeff Lokken in Wisconsin (who is also my age), someone 

always willing to read my prose written in a frenzy. He was busy watching his grandchild and was delayed in his response by the reality of a dirty diaper.

Below is what I wrote to him. The point
of the note was to get Jeff’s feedback on whether these principles remain solid bedrock and strong cornerstones to our achieving continued success for our client portfolios at FIM Group. All of this, despite the quick, easy, low cost, “no hard work” methods that are being championed everywhere today as the way to wealth.

Here is the list that I wrote to Jeff last night...

1. You get nothing for free.
2. You even get nothing for free in investing. / 2a. Low cost investing is about low cost. Low cost investing is not about striving for positive performance and good investment returns – it’s about cost.
3. Indexing/low cost simplified investing is not about optimizing investment returns.
4. We don’t think the world is an evil “rigged place.” / 4a. We do believe you must investigate before you invest.
5. We don’t believe that truth is an opinion – rather, we live in reality.
6. We believe history is more than what we remember and that inquiry, investigation, books and study, and always more research can help us make better investing decisions.
7. Everything is cyclical.
8. Hard work matters.
9. Success comes from hard work by talented, skilled, educated, experienced professionals.
10. Spreadsheets don’t make money.
11. PowerPoint presentations don’t make money.
12. Theories and hypothetical investing are like betting on a 20-year-old nag that won high profile races three times, in 1997, 1998, and 1999.
13. Values matter.
14. Virtue matters.
15. As you sow, so shall you reap – so we avoid companies run by dishonest people and corporations that don’t produce healthy and ethical products.
16. Our job is top reserve wealth, to make it grow, and to provide income and returns so that our clients can stay retired forever, retire someday, educate their kids, and leave a legacy. Our job is not to beat an index but it is about client outcomes – not being “only” down 20% when the index is down 28% (which is how many in the industry define success).
17. Life is good, values matter, and our work both as individuals and as a company is meaningful – and matters.

The real catalyst for this letter is risk parity. Don’t know what risk parity is? Most people know what risk is and what parity is but, as with “peacekeeper missile,” “conservative Democrat,” or “liberal Republican,” the definition is often obscured by bias and misuse of the term.

Risk parity is based on a fact set that would go like this: Since bonds are less risky (volatile) than stocks – but have lower returns – and since stocks have higher returns than bonds, the key to success is to manage your volatility by having more bonds if you want less risk but can be happy with lower returns, and, blah-blah-blah, then you end up owning more stocks and fewer bonds for more returns. The result of this is that portfolios end up being sufficiently bond-heavy, which is, well, great in the marvelous bull market for bonds that Jeff and I have lived through over the last 20 or so years. But bull markets don’t start when interest rates on bonds are at 2.25%. They start when rates are five times higher than that. So if you bought a 10% government bond 10 years ago, then hold it to maturity, you make 10%. Easy math. When you reinvest that money today, you get to reinvest at 2.25%. So over the next 10 years, you have locked in a 2.25% return. But bull markets for bonds do not start from 2.25% bond yields.

Jeff and I are old guys – we watched our parents cry when Kennedy was shot, knew what black-and-white televisions were, and read comic books that cost 10 cents or less. But, more important, we saw the worst bear market in bonds when we entered this industry. We watched bonds just have one bad year after another, so we know that all things, whether good or bad, come to an end, or at least change. 

“Right” or “wrong” depends on which side of the market you’re on. Well, at FIM Group we don’t own 30-year government bonds, and the bonds we’re favoring are 10 years or under and mostly have interest rate resets so they actually benefit from prices going up. What’s the point of this essay, then? That things change, and that all you need to do is visit any news site, even the ones on Facebook, to realize how good things
“they are a’changin’.”

Our January newsletter will discuss how we see things changing, what trends we see, and how all these new global presidents and prime ministers will influence the markets. We will even discuss some of the trends that President Trump will accelerate. We are already experiencing some consequences before he has taken office: (1) interest rates increasing, (2) world trade uncertainty, and (3) energy prices fluctuating, which of course is good or bad depending on how you’re invested, your industry, or your personal circumstances. Jeff and I live in the real world of dirty diapers, adult children with strong opinions, and shifting through the perceptions of what’s going on to see what is actual reality. In the investment world, the landscape is changing, but the truth is that “simple,” “inexpensive,” “easy,” and “no-risk” are not realistic attributes if you want a successful outcome. Portfolio insurance or a volatility management thesis of 2017 will look good on a spreadsheet or in a PowerPoint presentation, but if history is any guide, then history itself is the guide to use – not some random spreadsheet theory.

I figure I have changed more than 14,000 diapers in my parenting career, and have made millions of trades in the career as a money manager. Just like parenting, my career is still fun, and ever-challenging, but of course stinkers come along – and that’s the simple reality. Your success, of course, depends on how you respond to reality. Life changes, yet values and principles endure.

Welcome to 2017 / Happy New Year

Paul and the team at FIM Group