By
Casey
Smith
:
This is the 16th piece in our Positioning for 2012
series. Readers can find the entire Positioning For 2012
series
here
.
Casey Smith is President of
Wiser Wealth Management
, a Marietta, Georgia-based fee-only fiduciary wealth
management firm offering asset management, tax preparation,
estate planning and financial planning services. Wiser's unique
investing techniques have earned Casey speaking engagements at
top ETF conferences around the world. When not running Wiser
Wealth, Casey doubles as a pilot for an Atlanta-based commercial
airline.
Seeking Alpha's Jonathan Liss recently spoke with Casey to
find out how he planned to position clients in 2012 in light of
his understanding of how a range of macro-economic and
geopolitical trends were likely to unfold in the coming
year.
Portfolio Construction
Seeking Alpha ((
SA
)):
How would you generally describe your investing
style/philosophy?
Casey Smith ((
CS
)):
Wiser Wealth Management is a fiduciary fee only wealth management
firm. Our investment philosophy is to maintain a diversified
portfolio, keep costs low and always invest for the long-term.
As portfolio managers, we believe that long-term investing
should focus on the use of index funds (Index mutual funds, ETFs or
ETNs) as the only vehicles for investing. Very few active managers
have beaten their assigned index over long periods of time. This
also means that we will not attempt to time the market, make
emotional short-term portfolio decisions or place large bets on any
single sector or asset class. We seek to invest in long-term
healthy asset classes.
Diversification is key to any portfolio. Our portfolios tend to
have exposure to fourteen global asset classes. We choose these
assets classes based on the historical long-term risk of holding
these investments as well as what we call common sense future
expectations. Through the use of index funds, we generally have
portfolios that hold more than 3,200 stocks and over 6,000 bonds,
thus we virtually eliminate company risk and focus on asset class
and market risk.
Keeping average portfolio costs below 50bps also increases the
client's rate of return, compared to costs associated with active
managers and expensive brokerage houses.
SA:
To better understand your process, which are the 14 asset classes
you split portfolios into? How do you decide what allocation to
give to each?
CS:
We currently have client models exposed to the following indexes:
US large cap dividend focused, the S&P 500, S&P 400,
S&P 600, Developed Europe large cap equity, Developed Europe
equity with a dividend focus, Developed Europe small cap equity,
Emerging Markets equity, Emerging Markets equity with a dividend
focus, Frontier markets, US commodities, the US Aggregate Float
Adjusted bond index, Treasury Inflation Protected Bonds,
International Treasury Bonds held in local currency, US High Yield
Bonds, US Preferred Stock, 1-5 year US Treasuries, Short maturity
corporate bonds and cash.
We manage five models ranging from conservative to aggressive.
Many of our clients fall into an income growth model. This
particular model has 30% exposure to world equity markets and a
total portfolio cost of 0.33%.
We focus on asset class risk when building a portfolio. Using
the income growth model as an example, we have assigned a risk
number of 6 to the portfolio, meaning that we want the average
long-term standard deviation of this portfolio to be no greater
than 6. We select from the assets classes mentioned above based on
long-term standard deviations while also taking into account future
realistic expectations. For example, long-term bonds would not have
the same outlook as the results from the last 10 years. We want a
portfolio yield of 3.5%. This is obtainable only by having a value
tilt to the equity portion while keeping bond duration short to
reduce the threat of rising interest rates into the future. We look
to keep our client annual withdrawals to be no greater than 3-4.5%
of the portfolio value. This will keep them from withdrawing
principal, unless of course they plan a principal drawn down as
part of their investment policy/retirement plan.
SA:
Name one investment that exceeded your expectations in 2011, and
one you had high hopes for that didn't pan out. Do you see any
particular investment surprising investors over the next year?
CS:
Treasury Inflation Protected Securities (
TIPS
) are guaranteed by the US Government and help investors keep up
with inflation. The principal of TIPS increases with inflation and
decreases with deflation, as measured by the Consumer Price Index.
We did not think that inflation was going to be a real threat to US
investors in 2011, however my team certainly wanted to still be
invested in TIPS as a long term healthy asset class. Our ETF choice
for TIPS is Pimco's 1-5 Year TIPS Index (
STPZ
). The fund currently yields 3% and has returned 5% in 2011. With
the S&P 500 posting a lesser yield and 2011 total return, TIPS
are a bit of a surprise winner.
In 2010 we believed that the dollar would continue to fall
versus world currencies for the foreseeable future, and we wanted
to take advantage of this. Certain advertisers would have you
believe that owning gold would be a good hedge, but historically,
gold does not have a negative correlation with a falling dollar.
Another option was to use a currency fund, but in doing so our
investors would not actually own any currency - just future
contracts, which have added risks. So we elected to useiShares
S&P/Citigroup International Treasury ETF ( IGOV). This ETF
invests in foreign treasury bonds in their local currency. This
allows our investors to own a real asset, receive a dividend of
just over 3% and have a near 95% negative correlation to the US
Dollar. We started the year off very well; however the European
Debt crisis brought down the euro, which has a good representation
within the fund. The year to date return for IGOV is 0.03%, less
than our expectations.
For 2012, we could see emerging market index's showing us big
returns in portfolios if there is some debt reconciliation within
the Eurozone. Our emerging market ETFs areVanguard Emerging Markets
ETF (
VWO
) (-15% - all numbers are for FY2011),WisdomTree Emerging Markets
Equity Income ETF (DEM) (-9%),WisdomTree Emerging Markets SmallCap
Dividend ETF (DGS) (-19%) and Guggenheim Frontier Markets ETF (FRN)
(-22%). This year WisdomeTree's dividend weighted funds certainly
outpaced the core index holdings. Currently the MSCI Emerging
Market Index has a trailing PE that sits near a 5 year low relative
to the trailing P/E for the S&P 500. This historically has been
a buy signal. Our clients' continue to dollar cost average into
these ETFs throughout the year, making the sell-off this year not
as bad as advertised for new investments.
SA:
To which index or fund - if any - do you benchmark your
performance? Has this changed recently, and if so, why?
CS:
On client reports we compare all portfolios to the S&P 500.
This is partly because that is an index that clients compare us to,
rightly, or not. The S&P 500 gets reported to them on all major
news sources, thus they are most familiar with it. We believe that
we should be comparing our models to a risk-adjusted index such as
Standard and Poor's Target Risk Indexes or the Dow Jones
equivalent. We are periodically doing this internally but have not
added this measure to client reports. Reporting both the S&P
500 and the appropriate target risk indexes is being
considered.
SA:
Do you believe gold is a genuine hedge in uncertain markets? If so,
how much exposure to it or other precious metals do you have? If
not, where are you turning for potential downside
diversification?
CS:
We have been looking for what Gold is correlated with. We are
reading in many places that it is both a commodity and a currency.
We see advertisements that it is the best inflation hedge and that
every investor must own it. In reality Gold is a lot like antique
furniture. It pays no dividends, making it only worth what you can
find a buyer for. We found low historical correlation with
inflation and the US Dollar, however it is almost perfectly
correlated with fear.
Our gold allocation comes within our preferred commodity
ETN,iPath Dow Jones-AIG Commodity Index Total Return (DJP). I
believe that it is about 5% of our allocation to DJP, which itself
ranges from 3 - 5% of our total portfolios.
We have also noticed that during times of global stress gold has
recently been selling off. This has been seen in the last few
months but also after Japan's natural disaster. The thinking here
is that countries will need to sell gold to raise real currency to
repair infrastructure or pay bills.
If you were depending on gold as an "end of the world" trade,
owning it outright would be better than through an ETF.
Historically hard liquor, cigarettes and guns become the new
currency, as we saw during the fall of the USSR. We do not provide
guidance here, just an observation.
Our clients take a long term look at portfolio performance. With
a focus on living on your yield plus 3%, short term market risk is
not as threatening. For clients approaching or in retirement, 10%
of their account is kept in CDs, Short term corporates viaPIMCO
Enhanced Short Maturity Strategy ETF (MINT) or cash to fund their
immediate financial needs. Longer-term downside diversification is
currently being handled by US Treasuries throughVanguard Total Bond
Market ETF (BND) andiShares Barclays 1-3 Year Treasury Bond ETF (
SHY). We also look to dividends to help increase portfolio yield
and decrease overall downside portfolio risk.
Global Markets
SA:
Will fear of Eurozone contagion continue to drive the market's
direction, and how are you protecting client assets from potential
fallout there?
CS:
Europe is another example of how intertwined the global economy is.
While Greece does not affect the US directly, it having a negative
effect on France and Germany does. Now we have to consider the
viability of Italy and Spain. For the first two quarters of 2012 we
see this as the largest obstacle to US markets having a positive
start. It is hard to imagine the Eurozone breaking up, but that
probability is a growing risk. If the countries do stick it out for
the greater economic good, local control of finances will have to
be diminished. Either option is difficult to implement and will
have market implications worldwide.
We still believe that Europe will be a long-term healthy asset
class. It will be a more attractive investment, as the deleveraging
process is gradually completed. We have not changed our foreign
allocation with our models. As we rebalance, we are purchasing more
of Europe at these lower prices. Our more conservative models are
using WisdomTree DEFA ETF (DWM), a focus of dividend paying
companies within Europe, the Far East and Australia. Year to date
DWM is down 10% versus the standard in European investingiShares
MSCI EAFE Index ETF (EFA) which is down 13%.
U.S. Market
SA:
We are coming up on an election year. Will this be good or bad for
markets? Are you positioning for different potential outcomes?
CS:
We are standing at a crossroads. We can go the narrow path and
rebuild on our country's long history of innovation and hard work,
or we can get on the highway of seeking entitlements and protesting
every hard working American who has benefited from capitalism. The
latter is much easier.
The ability of the US to recover from hardships has not been
because of our government's actions but because of the will of the
American people. I have covered the world and of all the developed
nations, the US has the hardest working and most creative
population. We have a winner's "can do" mentality. However our
newer generations are not always willing to put forth the effort.
Instead we see protest for entitlements that they somehow feel that
they are obligated to receive. This is our biggest long-term threat
as it changes how we think about business and capitalism.
This next election could have implications on the stock market.
The current President has had 3 years of on the job training with
no prior real leadership experience, going up against one of two
Republican presidential hopefuls that have decades of real business
experience. This has to be good for US businesses, employees and
investors. I do not think that there is much needed to start
business growth at this time other than a good "we're behind you"
speech from a President that actually understands how to run a
business, versus protesting them.
There are individual sectors that would benefit from a changing
of the guard at the White House. However being
diversification-focused indexers, we are not as concerned about
these sectors as we are about overall market performance. A
Democrat vs. a Republican White House does not drive our model
allocations but is fun to talk about.
SA:
Are U.S. stocks cheap on the whole right now, or are current
valuations misleading in a market environment where fundamentals
can significantly worsen very quickly?
CS:
A 10-year treasury bond currently yields 1.91%. TheiShares S&P
500 Index ETF (IVV) yields 1.95%. An ETF with a dividend focus such
asiShares High Dividend Equity ETF (HDV) yields 4%. These are
compelling cases for new stock investments with 10-year time
horizons.
That being said, a bad headline out of Europe can cost a US
equity investment easily 3% to the downside in just a few hours or
days. Investors with new money should be dollar cost averaging
their way into the market while taking the approach that no matter
what happens, they're in it for the long haul. Pulling money out
because they "feel like the market is going to drop" is poor
behavior that if they repeat over and over at the wrong time will
simply make them broke. Fear is not an investment strategy. If they
cannot handle the market's ups and downs, then they should allocate
more to short term bonds or take the low yields on CDs.
At no point should anyone consider an annuity product.
SA:
Is the housing market in U.S. still an issue or not so much
anymore? Will prices continue to fall? Do you have exposure to
either REITs or residential real estate in client portfolios?
CS:
Real estate is local. Specific private real estate investments can
be made in local markets that would make sense, however nationally,
we see flat to declining prices, mostly due to the high employment
rate and those that are underemployed or jobless having to face
foreclosure.
We currently do not have exposure to REITs within our models. We
still do not see this as a long-term healthy asset class. Going
forward we may considerVanguard REIT Index ETF (VNQ), but currently
have no plans to add it to our models.
Bonds/Fixed Income
SA:
Where do you see Treasury yields in 12 months? Are Treasuries worth
buying at current (low) yields? For clients requiring income, where
have you been turning in this low yield environment?
CS:
The direction of Treasuries seems to depend on what happens in
Europe or the next crisis. In twelve months we could easily see
similar yields to today. Investors are certainly not buying
treasuries for the yield, but for safety of principal.
There is a reason why a high yield bond has its yield. They're
not handing out free money. Rather than chasing yield we have been
focusing our conservative and Income portfolios on dividend paying
stocks. This is a great way to increase yield while maintaining
overall portfolio risk. Adding iShares High Dividend ETF ([[HDV]],
yield 4%), PowerShares' S&P Low Volatility ETF ([[SPLV]], yield
3.3%) or State Street's SPDR Dividend ETF ([[SDY]], yield 3.2%) can
boost yield compared to the S&P 500 and historically has lower
comparative volatility. Investors looking for US small and mid cap
dividends should also considerWisdomTree MidCap Dividend ETF (DON)
andWisdomTree SmallCap Dividend ETF ( DES).
SA:
Have you changed your allocation to muni bonds in client accounts?
Do you view them as riskier than they have been in the past given
state and local budget challenges?
CS
: Three years ago we invested directly into muni bonds for clients.
They were the "just like" treasury trades with low or no tax
implications. As the insurers to the munis went out of business it
became apparent that these investments were certainly not "risk
free." We certainly view them as riskier and certainly would prefer
them within an index fund rather than individually.
We currently are not using munis within our models. The benefit
of using them at this time does not outweigh the opportunities that
we see in other healthier asset classes.
SA:
What is the ideal asset allocation for someone with a long-term
horizon (greater than a decade) and no need to touch their
investments? Can investors continue to rely on stocks after the
'lost decade' we just experienced?
CS:
Investor behavior is the most important ingredient to a successful
portfolio. Selling when fearful at the bottom of a cycle and buying
when greedy at the top is not a sound investment strategy, yet
everyone from individual to institutional investors participate in
this capital destroying behavior. We hear buy and hold is dead. I
always respond to this question with buy and hold what? Individual
stocks? Gold? The S&P 500?
Buy and hold investing is certainly not dead; you just have to
apply it differently than what finance textbooks set it up for in
the past. Holding bonds, large, mid, and small cap stocks with a
little international stock mixed in creates a good core, but there
are more global asset classes to consider. Your choices are
emerging market stocks and bonds, perhaps frontier markets,
international bonds, real estate, commodities and, while not
exactly an asset class, equity dividends. You allocate within these
asset classes to achieve a clearly defined risk objective. Retired
investors are looking for the maximum gain for the least amount of
risk, while young investors are looking for a maximum gain for a
given amount of risk.
For 10 plus years of investing, the risk/reward of the last ten
years points to a moderate or moderately conservative allocation.
Our moderate risk portfolio breaks down into the categories
below:
click to enlarge
Disclosure:
Casey Smith's clients hold positions in STPZ, IGOV, VWO, DEM, DGS,
FRN, DJP, MINT, BND, SHY, DWM, EFA, HDV, and SPLV.
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