Asset Management Letter

Q2 2018 Asset Management Letter

August 31, 2018   ·   By   ·   No Comments   ·   Posted in Asset Management Letter, News, Newsletters

Working Capital

We recently listened to a TED talk called “The Meaning of Work” and we couldn’t help but think about our recently retired colleague Janet Medlock and the parallels to our team at Creative Financial Group. In particular, Margaret Heffernan speaks to truly robust and dynamic firms building social capital, a fancy word for trust, over time. In contrast, a hyper-focus on performance leads to a lack of candor and support, whereas the compounding effect of a team with strong social capital gets better over time. We like to think our team at Creative has been like this for years and with our recent additions, Helen and Torey, we feel our crew will only get stronger. Of course, we are fully aware that Janet brought a lot to the table. However, given as many as Janet helped with their retirement, it was time for her to practice what she preached and we are happy for her. Rest assured though, our team remains focused on what Aristotle called the telos of what we do at Creative. Telos is defined as “our inherent purpose” and many from Aristotle to Frankl have pointed to it as something that pushes us all to higher and higher levels of performance. We would point to the concept of telos and the environment full of social capital as to why we constantly question and persevere.

For example, in a candid group like we have at Creative, one can question the sage wisdom of elite institutions since we consider our clients’ concerns paramount to any fear of ridicule from the ivory tower. For instance, private equity, like real estate in the 2000’s and technology in the late 90’s, is one of the hottest investments around currently. The industry touts 1990 to 2010 annualized returns of 14.4% and the diversification benefits of private equity, but leaves out the valuation argument while some of its proponents refer to it as “a superior form of capitalism”. Please remember there is always logic behind each asset bubble, a set of ideas that form the foundation of consensus thinking and it should be questioned. Regarding private equity valuation, returns quoted from 1990 were based on investments made at four to six times earnings with debt of three to four times whereas new offerings trade at a more elevated 11 to 13 times earnings along with dangerously more debt of six to seven times earnings. Simply put, you are paying a great deal more for an illiquid asset while incurring more debt. Debt used judiciously is okay, but more of it always introduces more risk. Interestingly though the pundits point to the reduced volatility as reason to own private equity.

Let’s take the reduced volatility argument a little further. How can an asset class that is increasing debt loads from the companies it buys at elevated levels, tout reduced volatility? Herein lies the clue to the “superior” claim of private equity. In the private equity market, accounting firms often employed by the same private equity firm determine the prices of the firms they own. Consider that from December 2012 to September 2015 energy prices crashed by over 50% but private equity energy funds from the 2011 vintage were marked up 1.1 times higher during that same time frame. In a recorded phone conversation, the CIO of the Public Employee Retirement System of Idaho, refers to this “smoothing” effect as the “phony happiness” of private equity. In fact, a study by a George Washington University professor showed that if private equity firms adopted fair value accounting standards then the reported volatility of private equity would double. In conclusion, the perceived safety of private equity feels shaky at best to us and at worst, deceptive. Given our “telos”, we will continue to shy away from investments that sound too good to be true.

Finally, we come around to the diversification argument used by private equity firms although this is somewhat tied back to the internal reporting issue we noted earlier. David Swensen at Yale adds a prestigious voice arguing the point about the long term and diversified nature of private equity where money is illiquid, for five to ten years versus the public market. Of course, we wholeheartedly agree with this sentiment. If you are forced to hold your investments between five and ten years, while you receive questionable but comforting pricing reports, then we believe your returns will be much improved, compared to the public market. Variable Annuities fall into this same bucket, in our opinion, if you can’t get to your investments easily, oftentimes the performance is better.

We realize we went down a rabbit-hole on private equity this quarter, but it was our intention to highlight how our team continues to compound and work our social capital. We also continue to question the massive inflow into passive vehicles like ETF’s and index funds 9 years into a bull market while, as we stated last quarter, we are still able to find funds that beat their relative index on a risk/return basis since inception. To that end, in a Barron’s interview with Jack Bogle, considered the father of index investing, we noted that from 2005 to 2017 the average investor earned 5.5% in ETF’s and 7.2% in active funds. Meanwhile Berkshire Hathaway, Warren Buffet’s prestigious firm (Symbol BRK.B), is down 5.36% while the S&P 500 is up 2.65% as of 6/30/18. We say this facetiously but you could argue that one of the smartest guys in the world could use some private equity auditors before all of his money flows into an index.

Circling back to the theme of work, we close with the thought that robust companies succeed because conflict and candor is safe within their organization; because scratchy and impatient people are determined to think for themselves. We encourage that behavior on our team so we respect it with our clients and friends. Please, candidly, call us with any questions and concerns as we are here to think through this journey with you.

 

General Compliance Disclosures

Statements made via this letter are the opinions of Creative Financial Group (“CFG”) and its advisors, and are not to be construed as guarantees, warranties or predictions of future events, portfolio allocations, portfolio results, investment returns, or other outcomes. None of the information contained is intended as a solicitation or offer to purchase or sell a specific security, mutual fund, bond, or any other investment. Readers should not assume that the considerations, suggestions, or recommendations will be profitable, suitable to their circumstances or that future investment and/or portfolio performance will be profitable or favorable. Past performance of indices, mutual funds, or actual portfolios does not guarantee future results. Future results may differ significantly from the past due to materially different economic and market conditions; investments in securities or other financial products involve risk and the possibility of loss, including a permanent loss of principal. Investments are not FDIC insured and have no bank guarantee.

Creative Financial Group (“CFG”) is a division of Synovus Securities, Inc (“SSI”), member FINRA/SIPC. Prior to January 1, 2011, CFG was a separate registered investment adviser affiliate of SSI. Investment products and services are not FDIC insured, are not deposits of or other obligations of Synovus Bank, are not guaranteed by Synovus Bank and involve investment risk, including possible loss of principal amount invested. Synovus Securities, Inc. is a subsidiary of Synovus Financial Corp and an affiliate of Synovus Bank.

Investment products and services provided by Synovus are offered through Synovus Securities, Inc. (“SSI”), Synovus Trust Company, N.A. (“STC”), GLOBALT, a separately identifiable division of STC and Creative Financial Group, a division of SSI. Trust services for Synovus are provided by Synovus Trust Company, N.A. The registered broker-dealer offering brokerage products for Synovus is Synovus Securities, Inc., member FINRA/SIPC. Investment products and services are not FDIC insured, are not deposits of or other obligations of Synovus Bank, are not guaranteed by Synovus Bank and involve investment risk, including possible loss of principal amount invested.

Synovus Securities, Inc. is a subsidiary of Synovus Financial Corp and an affiliate of Synovus Bank and Synovus Trust. Synovus Trust Company, N.A. is a subsidiary of Synovus Bank.
Pursuant to rules adopted by the U.S. Securities and Exchange Commission governing federally registered investment advisors, we request that you take time to compare your account balances and statements issued by National Financial Services, who acts as the custodian for your account(s). We request you contact us immediately if you do not receive these statements or if the values reflected are materially different.

Cost basis reporting

If you buy and sell a security in a taxable account on or after the effective date, NFS will report cost basis for the sold security to you and the IRS on Form 1099-B. If you have a mix of covered and uncovered positions in the same security, NFS will report cost basis to you and the IRS for any covered position that is sold. NFS will apply the FIFO (First In, First Out) default method unless you inform us of a different method. Your cost basis method for all transactions must be final by settlement date. If you choose to change the default method, you can do so by notifying your Financial Consultant.

Use of Indexes

iThe investment return and style information and comparisons employ a variety of popular indices, and the index contents and strategies are the property of their respective companies (e.g., Dow Jones, Standard & Poor’s, Morningstar, Barclay Capital, Russell). Although the data is believed to be reliable, CFG makes no warranty with respect to the contents, accuracy, completeness, timeliness, suitability, or reliability of the information, which is represented here for informational use only and should not be considered investment advice or recommendation. None of the indices can be invested directly, and the return figures for these various securities indices are reported without management fees, trading costs, or other expenses subtracted from the returns, and are shown on a total return basis that assumes reinvestment of applicable capital gains and dividends. Components of indices may change over time. Small capitalization stocks are represented by the Russell 2000 Index. Mid Capitalization stocks are represented by the S&P Mid Cap 400 Index. Foreign stocks are represented by the MSCI EAFE Index and emerging markets are represented by the MSCI Emerging Markets Index.

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Creative Financial Group (“CFG”) is a division of Synovus Securities, Inc (“SSI”), member FINRA/SIPC. Prior to January 1, 2011, CFG was a separate registered investment adviser affiliate of SSI. Investment products and services are not FDIC insured, are not deposits of or other obligations of Synovus Bank, are not guaranteed by Synovus Bank and involve investment risk, including possible loss of principal amount invested. Synovus Securities, Inc. is a subsidiary of Synovus Financial Corp and an affiliate of Synovus Bank. You can obtain more information about Synovus Securities, Inc. and its Registered Representatives by accessing BrokerCheck