Business

The Bulls, The Bears, The Bulletproof Vest

and the
Secrets of My Success

By David C. Knipe, Temple Securities/Temple Asset Management

TURMOIL!
There is no other way to describe current stock market conditions and the negative effect they have had on the performance of most investor’s portfolios. Turmoil sounds terrible, but in today’s real time electronic environment stock markets will become even more volatile in the future. Every investor is going to have to deal with this issue and the strategy they choose to employ during a precarious market will determine their ultimate success or failure.

Given that we will invest in an increasingly tumultuous environment it only makes sense that we turn what is perceived as a negative occurrence into a tool that the investor can profit from. The right tool is what I call the “bullet-proof vest.” Let the Bulls battle the Bears. It will never end–such is the nature of the stock market–but if you stay clear of the trenches, and stay faithful to your bulletproof vest, it really doesn’t matter which side wins the daily battle; the investor who uses the right “tool” will always win the war.

The success that I have seen is mainly due to my choice of investment tools. I hope this article will help you find the bulletproof vest to ensure the growth and protection of your family’s wealth.

Wealth Management Tools in Today’s Marketplace
Wealthy investors everywhere have the same basic options when it comes to investing their hard-earned money in a professionally managed portfolio. The first is the common mutual fund, the second is to work directly with a private money manager.

Mutual funds are similar to privately managed accounts in two ways:
*They use the services of a professional investment manager who decides which investments to buy and sell and when.
*The manager follows a particular investment strategy or objective.

Beyond these two similarities, the differences between privately managed accounts and mutual funds are significant.

Minimum Investment Amounts
Privately managed accounts often appeal to high net worth investors who require flexibility in an investment vehicle so that their portfolios can match their specific goals. A typical privately managed account generally requires a minimum investment of $100,000 or more. Mutual funds however, can be purchased with only a few hundred dollars and therefore appeal to a broader, less specific investor.

The Importance of the Segregation of Assets
The managed account investor does not co-mingle their funds with the investments of other people. Unlike mutual funds where all investments are pooled, each individual security in a managed account belongs specifically to the investor. In addition, the investment manager works on behalf of the individual managed account investor–not a group of unit holders. This is an extremely important issue for the investor to consider, as a mutual fund that experiences high redemptions may be forced to sell securities which would negatively impact returns to the investor.

Costs
The overall cost of any investment management program depends on the level and amount of services provided to the investor. The normal fee for privately managed accounts with Temple Asset Management starts at 2.5% annually (well below the industry average of 3%), and may decline depending on the asset size of the account. This single fee covers a broad array of services, including establishing the investor’s financial objectives, asset allocation strategies, investment selection process, and the monitoring of the account’s performance. The single fee on the privately managed account also provides investors with custody services for investments and all transactions are executed free of commissions.

Total mutual fund costs are more difficult to calculate, as the investor needs to sum three distinct expenses: the mutual fund’s expense ratio, its transaction costs and any sales charge that may be levied against the investor to purchase or liquidate the fund units.

The mutual fund’s expense ratio includes the expenses for investment management, administrative costs and other operational cash outlays. Currently, the average stock mutual fund has a 1.53% expense ratio. It is important to note that that this expense ratio does not include the commissions the fund pays to dealers and brokers to buy or sell a stock.

Unlike privately managed accounts where the flat fee covers the costs of the trades, mutual fund commissions are absorbed into the purchase and sale of the securities of the fund. A mutual fund adds commissions to the price of stocks when it purchases them and subtracts them from the price when the fund sells them. Because funds do not report trading commissions in prospectuses, they must be estimated. It is reasonable to expect that the more trading the fund does, the greater its trading commission expenses.

Although quantification of the total cost of owning a mutual fund is difficult, and will differ from fund to fund, the costs of owning a mutual fund that does not actively trade versus investing with a private money manager are relatively comparable. The cost of owning the more active mutual fund may be significantly higher.

Investor Exposure
The investor is faced with another important question when choosing an appropriate investment vehicle. That is, the overall quality, integrity and safety of the invested funds.

The world of investing has recently seen an increase of “scams” and “schemes” promising guaranteed extraordinary returns well above what any reasonable product would offer. These schemes have ultimately resulted in the loss of most, if not all, of the investor’s principal investment. The basic rule that every investor must follow when investing anywhere is: If it seems too good to be true, it always is.

Other important questions the investor must ask before making their investment include:
*Education and experience of the investment manager
–Always ask for and verify professional qualifications
*Safety of the assets held on behalf of the investor
–Ensure investments are ultimately held by a reliable institution
*Dedication to claimed investment style
–The level of discipline the manager operates with
*Frequency, accuracy and completeness of statements
–Are statements provided at regular intervals and do they provide all details required to follow the progress of the portfolio?

Proper Wealth Management: It’s a Matter of Style
Currently only 1 out of every 12 mutual funds outperform the major market indexes! The main reason for this under-performance is also the major contributing factor causing the recent market volatility: Active Money Managers.

Active money managers use an aggressive approach, searching out and moving into the best looking opportunities, while quickly moving out of investments that are no longer perceived as attractive. There are two fundamental problems with this active approach. The first is that the majority of the managers are chasing the same few opportunities, which drives prices up while at the same time selling off the perceived unattractive holdings at ever lower prices as the managers race to liquidate.

The second problem is the significant cost the investor bears in this overall process. These costs include the commissions paid by the investor each time a manager buys and sells securities, the spread costs between the bid and offer prices of listed securities, and opportunity costs incurred over the period of shuffling the portfolio holdings. For most investment managers, the latter two–spread and opportunity costs–have much more significant bearing on portfolio performance than the commission costs. Given that most money managers today use this costly active investment style, it is no wonder why most mutual funds fail to outperform.

Investors have taken notice of this under-performance and have recently focused attention on more passive types of investment management where the manager keeps short term trading and turnover to a minimum while searching for attractive long term investments. This allows the passive portfolio manager to add value and return to the portfolio by avoiding the costs associated with active money management.

The most commonly used investment product for investors wishing to participate in passive money management are index funds and traded index units. These vehicles mimic the popular indexes like the S&P 500 and Nasdaq 100, as well as the more specific classifications within the broad indexes such as health care and technology.

Although these types of products do minimize management costs, their intrinsic details are often misunderstood by investors. The result is that the investor may possibly be placing themselves in a precarious investment situation through lack of diversification. For example, most investors who buy the Nasdaq 100 believe to be investing equally in 100 of the best companies listed on the Nasdaq exchange, when in fact only ten companies currently represent more than 38% of the entire investment. In this passive management situation, investors commonly acquire a false sense of security, less diversification than was intended, and assume the risk associated with a concentrated portfolio.

The active and passive money management styles described above are from both ends of the spectrum. In either case or anywhere in between, proper investment management relies on one main criteria: diversification.

The particular style that is right for each individual is as unique as that individual. It should be dictated by the culmination of information outlined in what investment professionals call the “Statement of Investment Policy & Goals.” This review should cover an investor’s Portfolio Objectives–including both risk tolerances and return objectives; Portfolio Constraints–including a description of liquidity needs, time horizons, tax considerations (where applicable), and other unique needs. The information contained within this statement should lead to the formulation of the investor’s investment policy which includes the recommended asset mix breakdown and finally, the portfolio management style.

The Bulletproof Vest
My wealth building strategy is not considered active nor passive; it is considered to be extremely disciplined. The overall strategy is derived from old money families and their professional wealth management strategies.

The main goal was wealth preservation, not wealth creation. To preserve their wealth, these families hired investment managers to invest in such a fashion as to insure its longevity.

To do this, the managers only invested in companies that offered a reasonably high growth rate with as little capital risk as possible. In general, they invested in companies where there was a strong likelihood that their share prices would move up with the market, but not move down as much as the market during corrections. In other words, they realized that wealth was not always made in good times when everything is going up, but in bad times by preserving capital when everything is going down.

These successful companies (both from a corporate and shareholder point of view) share many of the same characteristics including:
*persistence and consistency of earnings growth
*multinational corporate activities
*globally dominating brand names
*anti-cyclical businesses
*high relative internal return on equity

At Temple Asset Management, I continually analyze 600 companies to come up with investment choices that match the criteria listed. Out of the 600 companies, there are currently only 82 that make the cut. Listed below are examples of three companies that made the list, and two that did not:
A few that made the list:
General Electric Company: 35 year compounding return 12.4%, 20 year compounding return 22.7%
Coca-Cola Company: 35 year compounding return 13.7%, 20 year compounding return 21.3%
Merck & Company Incorporated: 35 year compounding return 15.1%, 20 year compounding return 21.4%

A couple that did not make the list:
USX-United States Steel Group: 35 year compounding return 3.5%, 20 year compounding return 6.4%
INCO: 35 year compounding return 1.3%, 20 year compounding return 1.8%

It is easy to see why choosing the right type of company to invest in makes a significant difference when investing for the long term. It is also important to note that if you choose to invest in index linked investments, you are buying many of the companies that would never make the list.

The notion of a bullet-proof vest for investors is nothing more than a concept. It is the culmination of knowledge, strategy, and discipline being applied to reasonable long-term investment expectations. If you are prudent and logical with the choices you make you will prevail.
Most investors I know seem to have some type of strategy but rarely follow through on the execution. The problems are greed and emotion. These two powerful human emotions make it impossible for most individuals to efficiently manage money, as they impede ability to consistently follow an underlying strategy. This is where a qualified private money manager most effectively adds value.

There is obviously much more detail to the investment philosophy that Temple Asset Management is built upon, but we have added significant value to our clients’ portfolios through the discipline and strategy we employ. In the last year, our U.S. portfolios generated a return of 10.39%–a 13.31% over-performance versus the Dow Jones Industrial Average–and our Canadian portfolios generated 65.16% return, an 18.60% over-performance versus the TSE 35.

A wise man once said, “Yesterday is history, tomorrow is a mystery, and today is a gift; that is why they call it the present.” Take some of the mystery out of tomorrow by giving yourself the gift of properly and effectively managing your wealth today. Put on your bulletproof vest!

David C. Knipe, B.Comm, CFA, is the President and CEO of Temple Securities Ltd. and the Chief Investment Officer of Temple Asset Management Ltd. He may be reached at (649) 946-5296 or email: asset@temple-group.com.



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