| Arete Quarterly Q111 |
Welcome
Warm winds breezed through Baltimore last week and with them came scents of spring and thoughts of vacations and beach trips. Of course such trips often involve a great deal of planning — for food, activities, and traffic. But what a great time we’ll have!
Not unlike retirement in many respects. We work hard and then look forward to
taking it easy and having fun. We take pleasure in anticipating just rewards. We may face some challenges and detours, but we fully expect to arrive at our destination. But what if we run out of gas along the way? What if we don’t have enough money saved to retire?
In her Financial Times article, “Americans have not yet learnt how to share pain fairly” Gillian Tett offers an interesting insight. “In a country built by pioneers, where resources seemed abundant and growth eternal, no one has worried about how to divide up the pie — after all, everyone assumed the pie would swell.”
This aspect of American character pervades many aspects of our lives, and we believe retirement planning is one of them. Financial advisors plug in long-term return assumptions for stocks in the high single digits, extrapolate several years ahead, and voila, an image of a couple comfortably retired on a beach front.
What if the assumptions of “growth eternal” are no longer correct though? Given the market’s powerful pattern of reverting to mean valuations over time, we believe there is very good evidence to suggest S&P 500 returns over the next seven to ten years will be a lot closer to zero than high single digits. How do retirement plans look under these assumptions?
This is what we call the “investment challenge.” If equity returns are near zero for the next seven to ten years, retirement portfolios, excepting regular contributions, will be no larger than they are today. Worse, once financial planning fees are trimmed off, there is a very good possibility portfolios in this scenario will shrink. Talk about running out of gas!
A big part of the reason Arete was formed was to present a constructive solution to this challenge. Essentially what we do is make people’s money work harder for them
— so they have a better chance of reaching their retirement destination. Of course, there are no guarantees, but there are absolutely opportunities to do this. It’s not magic, but it is hard work — and it beats the heck out of hitchhiking.
Warm winds breezed through Baltimore last week and with them came scents of spring and thoughts of vacations and beach trips. Of course such trips often involve a great deal of planning — for food, activities, and traffic. But what a great time we’ll have!
Not unlike retirement in many respects. We work hard and then look forward to
taking it easy and having fun. We take pleasure in anticipating just rewards. We may face some challenges and detours, but we fully expect to arrive at our destination. But what if we run out of gas along the way? What if we don’t have enough money saved to retire?
In her Financial Times article, “Americans have not yet learnt how to share pain fairly” Gillian Tett offers an interesting insight. “In a country built by pioneers, where resources seemed abundant and growth eternal, no one has worried about how to divide up the pie — after all, everyone assumed the pie would swell.”
This aspect of American character pervades many aspects of our lives, and we believe retirement planning is one of them. Financial advisors plug in long-term return assumptions for stocks in the high single digits, extrapolate several years ahead, and voila, an image of a couple comfortably retired on a beach front.
What if the assumptions of “growth eternal” are no longer correct though? Given the market’s powerful pattern of reverting to mean valuations over time, we believe there is very good evidence to suggest S&P 500 returns over the next seven to ten years will be a lot closer to zero than high single digits. How do retirement plans look under these assumptions?
This is what we call the “investment challenge.” If equity returns are near zero for the next seven to ten years, retirement portfolios, excepting regular contributions, will be no larger than they are today. Worse, once financial planning fees are trimmed off, there is a very good possibility portfolios in this scenario will shrink. Talk about running out of gas!
A big part of the reason Arete was formed was to present a constructive solution to this challenge. Essentially what we do is make people’s money work harder for them
— so they have a better chance of reaching their retirement destination. Of course, there are no guarantees, but there are absolutely opportunities to do this. It’s not magic, but it is hard work — and it beats the heck out of hitchhiking.
Business Update
I normally run across one show on TV each year that I really enjoy and make it point to watch. This year the show is “The Good Wife.” I enjoy the way the show captures much of the strategizing and maneuvering that is required to succeed in many important encounters. I also enjoy the way the show eschews black and white depictions and rather embraces the all-too.real “gray” areas with which we are all familiar. Somehow, the main character manages to navigate the landscape and remain “good”.
What does this have to do with Arete? As assets under management officially eclipsed $1 million at the end of the quarter, I had occasion to reflect on the business and how it has grown. It has grown by patiently finding and working with “good” clients.
From the start, I made a deliberate effort to avoid growing assets just for the sake of increasing revenues. While it is easy to see the allure of making more money short-term, longer term the result is almost always the same: Managers end up with “fickle” clients that leave at the first sign of volatility, and clients are eventually disappointed that the managers fail to meet expectations.
So I wanted to do something different with Arete. I wanted to focus on “good” clients rather just any clients. I wanted to build relationships rather than distribution channels. And I wanted to offer terrific investment value to people who appreciate it as such.
What constitutes a “good” client for Arete? A good client in many ways is someone who shares our views as to what constitutes a successful approach to investing. A long-term investment horizon, a preference for low turnover, and an appreciation of a valuation-based approach are all aspects of this. Good clients also share our skepticism of conflicts of interest and seek simple business models that avoid conflicts. In addition, good clients are also very sensitive to costs, preferring to pay a reasonable price for a robust research process, but foregoing the costs of elaborate sales efforts.
The single best indication of a good individual prospect for Arete, however, is when someone has an isolated lump of money. Perhaps the individual left a job and has a stranded 401(k) plan. Or a person may have sold an asset. In either case, a person has some money that is not currently being “managed” that he or she would like to be more productive.
Arete’s mission is functional excellence in money management — which really means helping people’s money work harder for them. Stranded or isolated assets are great situations for Arete because it allows us to focus on what we do best.
If you happen to know of someone who has a stranded 401(k) or another lump of money he or she may want to put to work, please let me know. I am looking to add a couple new individual clients this year and always appreciate the opportunity to help out.
Thanks and take care!
David Robertson, CFA
CEO, Portfolio Manager
I normally run across one show on TV each year that I really enjoy and make it point to watch. This year the show is “The Good Wife.” I enjoy the way the show captures much of the strategizing and maneuvering that is required to succeed in many important encounters. I also enjoy the way the show eschews black and white depictions and rather embraces the all-too.real “gray” areas with which we are all familiar. Somehow, the main character manages to navigate the landscape and remain “good”.
What does this have to do with Arete? As assets under management officially eclipsed $1 million at the end of the quarter, I had occasion to reflect on the business and how it has grown. It has grown by patiently finding and working with “good” clients.
From the start, I made a deliberate effort to avoid growing assets just for the sake of increasing revenues. While it is easy to see the allure of making more money short-term, longer term the result is almost always the same: Managers end up with “fickle” clients that leave at the first sign of volatility, and clients are eventually disappointed that the managers fail to meet expectations.
So I wanted to do something different with Arete. I wanted to focus on “good” clients rather just any clients. I wanted to build relationships rather than distribution channels. And I wanted to offer terrific investment value to people who appreciate it as such.
What constitutes a “good” client for Arete? A good client in many ways is someone who shares our views as to what constitutes a successful approach to investing. A long-term investment horizon, a preference for low turnover, and an appreciation of a valuation-based approach are all aspects of this. Good clients also share our skepticism of conflicts of interest and seek simple business models that avoid conflicts. In addition, good clients are also very sensitive to costs, preferring to pay a reasonable price for a robust research process, but foregoing the costs of elaborate sales efforts.
The single best indication of a good individual prospect for Arete, however, is when someone has an isolated lump of money. Perhaps the individual left a job and has a stranded 401(k) plan. Or a person may have sold an asset. In either case, a person has some money that is not currently being “managed” that he or she would like to be more productive.
Arete’s mission is functional excellence in money management — which really means helping people’s money work harder for them. Stranded or isolated assets are great situations for Arete because it allows us to focus on what we do best.
If you happen to know of someone who has a stranded 401(k) or another lump of money he or she may want to put to work, please let me know. I am looking to add a couple new individual clients this year and always appreciate the opportunity to help out.
Thanks and take care!
David Robertson, CFA
CEO, Portfolio Manager
Market Overview
In many important respects, very little has changed in the market from the last two quarters. Price momentum continued to strongly influence returns and high correlations among stocks persisted. In the short-term, these conditions tend to work against our strategy of picking unique, out-of-consensus stock ideas with strong long-term opportunities.
In addition, many of the same risks are still lurking, and some have worsened since our last report. While they have been largely ignored by the market, that does not mean the risks have disappeared.
One of the best ways to capture the dynamics of the market over the last twelve months is to breakdown Russell’s size and style returns. Over that period (3/31/10 – 3/31/11), the Russell 2000 Index® (small cap) return of 25.79% trounced the Russell Top 200 Index® (mega cap) return of 13.64%.
That only tells part of the story though. Within small caps, the Russell 2000 Growth Index® return of 31.04% trounced the Russell 2000 Value Index® return of 20.63%. In short, the market clearly displayed greater risk appetite with its preference for smaller stocks over larger ones. This occurred despite the plethora of lurking risks. From the perspective of a three to five year investment horizon, we do not believe stocks can continue to rise unabated given the very serious fiscal and debt issues that must be dealt with. In short, the continued underpricing and underappreciation of risk has left us more cautious than we were last quarter.
Our mental model of the landscape is for fairly volatile markets to persist with no sustainable trends for some time. We remain bullish about the fundamental prospects for our companies, but are very sensitive to diminished appreciation opportunities as prices rise. We continue to believe our stocks are largely protected against permanent impairments of capital due to our extensive financial analyses. On the other side, we continue to search for and pursue interesting new mid cap companies to refresh the portfolio. In both efforts, we try to take advantage of volatility by selling high and buying low.
In many important respects, very little has changed in the market from the last two quarters. Price momentum continued to strongly influence returns and high correlations among stocks persisted. In the short-term, these conditions tend to work against our strategy of picking unique, out-of-consensus stock ideas with strong long-term opportunities.
In addition, many of the same risks are still lurking, and some have worsened since our last report. While they have been largely ignored by the market, that does not mean the risks have disappeared.
One of the best ways to capture the dynamics of the market over the last twelve months is to breakdown Russell’s size and style returns. Over that period (3/31/10 – 3/31/11), the Russell 2000 Index® (small cap) return of 25.79% trounced the Russell Top 200 Index® (mega cap) return of 13.64%.
That only tells part of the story though. Within small caps, the Russell 2000 Growth Index® return of 31.04% trounced the Russell 2000 Value Index® return of 20.63%. In short, the market clearly displayed greater risk appetite with its preference for smaller stocks over larger ones. This occurred despite the plethora of lurking risks. From the perspective of a three to five year investment horizon, we do not believe stocks can continue to rise unabated given the very serious fiscal and debt issues that must be dealt with. In short, the continued underpricing and underappreciation of risk has left us more cautious than we were last quarter.
Our mental model of the landscape is for fairly volatile markets to persist with no sustainable trends for some time. We remain bullish about the fundamental prospects for our companies, but are very sensitive to diminished appreciation opportunities as prices rise. We continue to believe our stocks are largely protected against permanent impairments of capital due to our extensive financial analyses. On the other side, we continue to search for and pursue interesting new mid cap companies to refresh the portfolio. In both efforts, we try to take advantage of volatility by selling high and buying low.
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