Admittedly, the topic of tax inversions was nowhere near the top of things that I’ve considered blogging about. While certainly a timely issue (21 announced or completed deals since 2012 via Bloomberg), there are so many other topics that I believed our readers would be more interested in than any particular tax avoidance strategy. However, when I read last night that Burger King was in talks to buy Canadian chain Tim Hortons to move its headquarters to Canada, I thought there might be a surge in reader interest in the topic. You see, for many of our readers in the Northeast, a run to Tim Hortons for coffee and some Timbits is a near-sacred morning ritual.
Now that it has your attention, what exactly is a tax inversion and why would a company pursue such a maneuver? Put simply, a tax inversion is the decision by a company to reincorporate overseas in an effort to reduce tax exposure on income earned abroad. According to The Economist, there are two flaws in the United States’ corporate tax system contributing to such a decision. First, the United States’ corporate tax rate of 35% is the highest among the 34 member countries of the Organization for Economic Cooperation and Development (OECD, the average is 25%). Secondly, the United States taxes a company’s income no matter where it is earned, as opposed to some other countries that tax only income earned within its borders. In 2013, at least 42% of Burger King’s revenue came from overseas. Plus, the company doesn’t separate out revenue coming from the U.S. and Canada, so the number is likely even higher. Either way, it’s not hard to imagine Burger King wanting to lower the tax costs on this portion of its business and a Tim Hortons deal might be just the ticket.
While still in discussions, if Burger King were to merge with Tim Hortons, it would create the world’s third largest fast-food chain. The combined organization would have more than 18,000 restaurants. As a quick aside, to most people’s surprise, Burger King’s CEO, Daniel Schwartz, is only 33-years old (BusinessWeek did an interesting piece on him in July) and clearly, his role in the fast-food industry stands to grow much larger if such a deal closes. For what it’s worth, both companies have rallied following the news with Burger King (NYSE:BKW) up over +16% and Tim Hortons (NYSE:THI) up over +19%.
Now, given our bias towards index-based investing here at Nottingham, we don’t have any outright position in either company. However, we still find it important to follow these company-specific stories as they often tie back to larger macro-level issues. In this case, the topic of tax inversions has become a hot topic for many politicians, including President Obama. There is current talk in Washington on ways to curb such practices with reform being likely. It will be interesting to see how the discussion evolves over time and how it will affect the economy going forward.
Lastly, for anyone worried about what this will do to your daily coffee run, it was announced that if a deal was reached, the two companies would operate as standalone brands.
Until Next Time,
Chris Hugar, CFA
This past Saturday, the Nottingham team commenced it’s “Nottingham Helps” initiative to partner with local Not-for-Profits, volunteering our time to help meet the needs of the Western New York community. We began with the WNY Food Bank by volunteering to help with the Garden Project. The Garden Project has become a highly productive community garden with a committed participant base. Volunteers and staff guide the gardeners through all aspects of food production, from composting and mulching to preparing and planting seeds, weeding, managing pests and diseases, and harvesting. Throughout the growing season, nutrition and cooking lessons are offered to educate gardeners about different ways to consume and preserve their garden-harvested produce. To learn more about the Garden Project, click here.
Below are some pictures from Nottingham Helps.
A contrarian is an individual who takes a contrary, or opposing, view or action. More specifically, a contrarian investor is an individual who makes investing decisions that go against prevailing wisdom. A contrarian investor might buy an asset class that has underperformed as of late and is currently unpopular with investors. Alternatively, they might also sell a particular asset class that is continuing to hit new highs as it’s currently the flavor du jour of the majority. At its core, it all makes sense – contrarian investors are simply attempting to buy low and sell high.
But what underscores this general philosophy of occasionally opposing the crowd? Mainly, contrarians understand that the market is not made up of completely rational decision-makers (a false assumption often underlying economic models), but instead irrational human beings prone to emotions like greed and fear, which causes markets to overreact in both directions. Greed pushes investors into popular, pricey asset classes as the allure of future gains trumps conventional wisdom. At the same time, fear pushes investors out of asset classes as the psychological toll of recent losses forces common sense out the window. However, for those that can keep their emotions in check, a contrarian view at some of the more extreme points of market sentiment can produce bountiful rewards.
Let’s look at last year. Despite the S&P 500 returning +32.3% in 2013, certain areas of the market struggled. Emerging markets was the worst performing region of the world at -4.9%, REITs were shunned by investors (up only +2.3%), and gold got walloped (-28.3%).
Fast forward to 2014 and the S&P 500 is up a respectable +5.6%, but the real stars have been last year’s laggards – emerging markets up +7.7%, REITs up a whopping +17.9%, and gold up +8.7%. Only time will tell if this type of performance will continue through the second half of the year, but assuming their timing was right (admittedly a big “if”), investors have been rewarded in 2014 for stepping into 2013’s fray. Contrarian investing appears to be alive and well.
So, how do we incorporate this type of contrarianism in our process here at Nottingham? Over the short term, we do everything we can to remove emotion from our decision-making. We have multiple portfolio managers analyze and weigh in on different investment opportunities, and decisions are all data-driven. We view the market through an analytical lens and not an emotional one. If an area of the market has lagged of late, but the numbers make sense, we’ll make an investment. After all, these currently unpopular areas of the market often produce the best opportunities.
Over the long term, we rebalance. Rebalancing is the process of shifting an investment portfolio’s asset allocation back to the desired mix after some set period of time. For example, assume an investor wishes to invest in a portfolio containing 75% equity and 25% fixed income. After one year, stocks have rallied, while bonds have declined in value, pushing the investor’s mix closer to 85%/15%. Rebalancing would involve selling part of the equity portion and reallocating the proceeds to fixed income to push the portfolio back to a split of 75%/25%. Rebalancing ensures that an investor is selling their winners and purchasing more of their losers (buy low/sell high). Plus, the mechanical, rules-based nature of the process completely removes emotion from the equation.
While contrarianism isn’t an absolute rule that can be blindly followed (often times certain investments decline for good reason), it provides an interesting way to view the world to help keep some of our emotional extremes in check. Sometimes it’s cold and lonely away from the warmth of the herd, but often times, that’s exactly what’s needed.
Until Next Time,
Chris Hugar, CFA
Okay, I admit it. I’m a Baby Boomer. The first of the Boomers are now retired or semi-retired and we’re now looking at the 60’s and 70’s in our rear view mirrors (A.K.A. the coolest decades e-v-e-r!). Younger people can get away with the longer hair, dressing different, etc., but wearing madras and teasing hair is a thing of the past. What works now for Jimmy Buffett doesn’t necessarily work for you (although ‘Cheeseburger in Paradise’ will forever work).
The youngest of the boomers are now around 50 years old. At this age, you may feel you’ll never retire because you still have the energy and the drive to work so saving is taking a back seat to other things. Trust me, in time you will feel differently. Freedom to do what you want when you want is a beautiful thing. I know from experience. Chances are you will regret not thinking about saving when you find out you’ll have to work until you’re 80.
Fortunately, around 50, you can really ramp up your saving during the home stretch to retirement. By this time, it’s possible the kids are out of college and on their own and the house is paid off, along with most other debt. What’s more, you are now in your peak earning years. You can picture that summer beach house, so file your regrets away and let’s look to the future! Assuming you’ve been contributing to your IRA (traditional or Roth) and your 401K for some years, now is the time to amp it up even further. A general rule of thumb is to retire with savings roughly 20x your annual salary. It may sound over-the-top but with so many variables in retirement – better safe than sorry.
Let’s consider an example with the (almost always) hypothetical Smith family. Jim Smith and Mary Smith have paid off their house. Their only son, Herbie, has graduated college and is now out on his own starting his young career as a dentist. With a large portion of their fixed costs eliminated, the Smiths strive to fully fund an IRA and put the maximum in a 401K.
Suppose the Smiths max out on annual contributions for the next 15 years ($6,500 for an IRA and $23,000 for a 401K in 2014 for those over 50). Assuming a conservative 5% annual return, they would have $147,274 in their IRA ($6,500 X 15 years) and $521,122 in their 401K ($23,000 X 15 years). Their savings would soar to $668,396! Not included in any of this is the employer match or any other savings they made prior to this. Along with Social Security and possible pensions, their retirement is looking nicer and nicer.
Now, expecting everyone to make the maximum contribution is not realistic. Not everyone has the luxury to do that, but my main point is that the time to start saving is now. You can enjoy life to the fullest and still be diligent in saving for your future. Everyone is different, but get as aggressive as your situation permits. The IRS has some different rules surrounding maximum contributions for those under 50 or those above certain income thresholds, so consult your accountant and get moving. It is never too late. Retirement is filled with great richness and emotional clarity, but try not to rush it either.
A wise man once wrote, “Grow old with me, the best is yet to be.” I think he may be right.
In the past, I have highlighted some serious risks to investing success from topics as timeless and simple as avoiding unreasonable portfolio costs to more timely market risks like warning signs of future inflation. Today, I want to share some quick thoughts on a risk that most individual investors wrestle with everyday – financial procrastination. Similar to the “this is my last tasty (but unhealthy) meal…I’m starting tomorrow” diet, financial procrastination is when individuals put off all of the important things they need to do to be a successful investor. It’s when tomorrow turns to next week and then next week turns to next month. The next thing you know, it’s been a year since you meant to rebalance your portfolio or sell that individual security.
Take for example the so-called “orphan 401K” – it’s when an individual leaves a job and the retirement assets that they accumulated in their past employer’s 401K plan sits idly, unmanaged and neglected. Most people plan to roll these assets over to either an individual IRA or to their new employer’s 401K plan, but inevitably life gets in the way. It’s not just 401Ks either. Many individuals have opened up various investment accounts along the way and most sit unattended with no real plan in mind. Fortunately, it’s easy to fix these issues. All it takes is a little will power.
Continuing our example above, let’s assume someone sits down and rolls one or even all of their old 401Ks into an IRA. What are the benefits?
This is just one example and clearly there are potential benefits to be had. While some of these things may seem small, they can lead to huge improvements over time. Ultimately, while it’s important to consider all the factors at play before making any type of financial decision, I think the lesson here is to just not put it off. Consider all the factors, make a decision, and then execute.
Retirement may seem far away so it’s easy to push things off for things that seem more timely, but it’s more important than you realize. So consider this your call to action – take one or two of those things you’ve been meaning to do and push it to the top of your list today. Trust me, it’ll be worth it.
Until Next Time,
Chris Hugar, CFA
Most people have probably heard at some point that the stock market is “forward-looking,” but what does this mean? Equities (and most financial assets for that matter) are not valued on their current performance, but instead on their future prospects. While no one in our business likes to think about 2008, it can serve as a pretty good example of this. In March of 2008, things looked grim – home prices were in a free fall, manufacturing had cratered, consumers were hurting, and millions of people had lost their job and sat unemployed.
Despite all of this, the S&P 500 bottomed on March 6th, 2009 at 683. At that point, stocks weren’t being priced off of the current (terrible) conditions, but instead the (improving) outlook going forward; stocks began pricing in a recovery. The S&P 500 subsequently rallied, ultimately returning +26.5% in 2009, even though economic activity still rested in the doldrums. Had someone waited for economic activity to completely recover before investing, they would have missed out on a significant part of the current rally.
Now, with the value of financial assets providing some insight into the future, can we take anything from recent market performance? One thing that we’ve been intrigued by here at Nottingham has been the year-to-date performance of our Real Return Strategy. The strategy seeks to produce long term returns in excess of the U.S. Consumer Price Index (CPI) by investing in securities that traditionally perform well during inflationary periods. In a nut shell, it’s a hedge (or insurance) against inflation.
Interestingly enough, despite little talk of inflation right now, the strategy has been our best performing portfolio thus far in 2014. Even with the S&P 500 up a very respectable +7.5% year-to-date, many of the strategy’s asset classes have still managed to either keep pace with or outperform domestic equities.
While the market’s forward-looking mechanism isn’t always perfect (several asset class bubbles prove as much), it’s usually pretty good. Is the recent bid in inflation-friendly asset classes a sign of things to come? Only time will tell. However, for fixed income investors (whose biggest fear is inflation), it is surely food for thought. While there is no way to be certain if this performance is hinting at things to come, we can tell you that inflation is not on many investors’ radars right now and that is usually a good time to consider preparing for it (when those assets are unwanted and cheap). Regardless, it is definitely something to think about as the market may be providing investors a subtle “heads up.”
Until Next Time,
Chris Hugar, CFA
When we started this blog, one of the things we wanted to do was share with our readers some of the core beliefs behind our approach to portfolio management. For example, in June, I wrote about the importance of maintaining a global worldview when investing, a key aspect of our process here at Nottingham. In this post, I want to highlight another important part of our approach: the role of portfolio costs on performance. Why is this important? It’s pretty straightforward – the less that is removed from a portfolio by fees, the more an investor gets to keep.
Consider that the average cost for a mutual fund holding large cap U.S. stocks is 1.18% of assets. Taken alone, that might not seem like a lot to some people. However, mutual fund companies have done a good job disguising the overall level of fees by presenting expenses relative to total assets. A more apt approach is viewing these fees relative to the level of returns that these funds provide. For example, the average annual return on the S&P 500 since 1994 has been +9.22%. In that light, a reasonable sounding 1.18% of total assets actually represents almost 13% of the returns generated each year! Unsurprisingly, that can have devastating effects on the growth of a portfolio over time.
At Nottingham, one way we work to mitigate this is by using exchange-traded funds (ETFs) to construct client portfolios. ETFs are passively managed, meaning they opt to replicate market returns rather than attempt to beat them. On the other hand, most mutual funds employ active management with the overall goal of beating the market (although most usually don’t). The “hands-off” approach of market replication allows ETFs to charge a lower management fee as they aren’t burdened by the high paid portfolio managers and pricey research costs associated with active management. At Nottingham, we attempt to widen this natural cost advantage even further by making an ETF’s expense ratio a key variable in our selection process.
The easiest way to illustrate the impact of fees is to provide an example. Let’s assume an investor invests $1,000,000 in the S&P 500 in 1994. The chart below highlights the growth of that $1,000,000 based on the return of the S&P 500 less either, (a) the average fee of a mutual fund, (b) the average fee of an ETF, or (c) the average fee of a Nottingham ETF.
Based on the chart above, it is easy to see that fees matter. The almost 1% difference in expense ratio compounds over time, leading to a remarkable $1 million difference in outcome. Fortunately, in our book, a basis point saved is a basis point earned and controlling costs within a portfolio is one of the easiest ways to improve an investor’s outcome over time. That is why we have built our process around keeping these costs in check and ensuring that our clients get to keep exactly what they deserve.
Until Next Time,
Chris Hugar, CFA
First things first. From all of us here at Nottingham, I hope everyone enjoyed the long Fourth of July weekend.
It only seems fitting that, following a holiday that celebrates the very best of the United States of America, I highlight some of the recent signs of strength concerning the U.S. economy. Despite the first quarter’s abysmal GDP number (-2.9%), the data since then has pointed to a rebound in growth. Manufacturing continues to see gains and consumer confidence is trending higher (June’s readings recently surpassed expectations). Housing appears to be on stable footing with both new and existing home sales in May coming in above expectations. Most recently, Thursday’s unemployment report provided its own fireworks. Nonfarm payrolls increased +288k month-over-month, smashing expectation of +215k, and on top of that, April and May also saw revisions higher.
Given the data, it is not surprising that the Fed has continued to taper its asset purchases. In stark contrast, serious concerns surrounding growth in Europe and Japan have pressed the European Central Bank (ECB) and the Bank of Japan (BoJ) to push even more accommodative policy in hopes of further stimulating their respective economies.
With U.S. growth comparatively stable and Fed policy diverging from that of the ECB and BoJ, the U.S. currently appears to be in a good position relative to the rest of the world. This strength has the potential for some implications in a market where comparative analysis is king – foreign currencies. In the simplest terms, exchange rates are driven by the demand of holders of one currency to obtain another currency and vice versa. It’s all relative.
Since the bursting of the “dot-com bubble” in the early-2000s, the dollar has been on a fairly steady decline versus a basket of other major currencies (see below). The greenback became less and less attractive to foreign investors as U.S. interest rates fell and the country became less competitive (growth slowed, manufacturing sent overseas, etc.). However, fast forward to today and the contrasting stances by global central banks appears primed to send U.S. interest rates higher and a renewed U.S. competiveness is underpinning rebounding economic growth. With that as the backdrop, it would come as no surprise if the trend in the dollar reverses and the greenback begins to strengthen.
While all of our clients have absolute exposure to the dollar through the bulk of their portfolio holdings (U.S. equities and bonds are all denominated in dollars), it is relative exposure to the greenback that has the potential to enhance performance. So, how does one gain this exposure?
At Nottingham, we’ve taken a position in the WisdomTree Bloomberg U.S. Dollar Bullish Fund (Ticker: USDU) in our Global Equity, Global All-Asset, and Global Balanced strategies. This ETF uses positions in short-term currency forwards to gain exposure to the performance of the U.S. dollar against a basket of other currencies, namely the Euro and the Yen (about 50% of the basket). Not only that, but we have also added a position in the db X-trackers MSCI Japan Hedged Equity Fund (Ticker: DBJP). This ETF holds a collection of Japanese equities and is also short the Yen. That means that DBJP will not only benefit from an increase in the value of Japanese stocks, but it will also benefit if the U.S. dollar strengthens versus the Yen.
In closing, with Independence Day and the requisite warm weather, hot grill, and bright fireworks display just behind us, it is important to reflect on the United States and its current position in the world. Just remember that the country’s relative strength is not only a boon to the red, white, and blue, but also potentially the green.
Until Next Time,
Chris Hugar, CFA
At Nottingham, we take a core-satellite approach to portfolio management. This means we split client portfolios into two (equally important) parts. The core of the portfolio includes broad exposure to traditional asset classes based on a client’s risk tolerance, while the portfolio’s satellites are a collection of our best ideas. We attempt to enhance portfolio performance by using these satellite positions to invest in areas we find attractive, such as a certain sector or a particular country.
Financial markets are hugely dynamic and as we weed through all the noise, we come across a lot of “good” ideas. However, most of those never make it into client portfolios. That’s because we only invest in our most compelling ideas. Investment management can be tricky. Even when we like a particular investment, there is always the risk that it won’t work out. By sticking to only our best investment ideas, we control this risk by making sure that the odds of success are in our favor.
Sometimes we don’t have any “great” ideas and that’s okay. The professional money managers that claim to have an endless supply of brilliant ideas aren’t nearly as discerning and they’re typically the ones with a much lower success rate. Rather than include low conviction investments in client portfolios, we wait for the right opportunities to present themselves.
Although patience is a virtue, this can raise its own set of challenges. For example, what happens when we remove a satellite position from the portfolio and we don’t have a great idea for a replacement? How do we manage that situation? Sometimes, we take the proceeds and hold it in cash. This may be because we are getting close to making another investment and we want to have the cash on hand. This could also be to position the portfolio more defensively if we aren’t entirely constructive on the overall market.
But what happens when we already have enough cash in the portfolios to manage any future investment or liquidity need and we have a favorable view of the market? Cash equitization. Cash equitization is just a fancy finance term for the simple process of taking cash and investing it in broadly focused ETF’s to maintain market exposure. This prevents cash from weighing on overall portfolio returns when markets go up (so-called “cash drag”).
This is best illustrated by an example. This year, we owned a position in the Market Vectors Oil Services Trust (Ticker: OIH) in both our Global Equity and Global All-Asset strategies. The position was a fantastic performer for us, outpacing the S&P 500 by +11% on the year, which we subsequently captured by recently exiting the position.
Comfortable with current cash levels, we allocated the proceeds to the iShares S&P 500 ETF (Ticker: IVV) and the iShares MSCI ACWI ex-US ETF (Ticker: ACWX). We chose IVV and ACWX because they are low cost (0.07% and 0.34%), extremely liquid, and match up well with our domestic and international benchmarks. If markets move higher from here, the value of these positions will increase and we will eventually sell both IVV and ACWX to fund future high conviction investments.
So, the next time we exit a satellite position, I can’t tell you whether we will put the proceeds in cash, another satellite position, or an equity market proxy – that will depend on our current view of the market – but I can tell you that we will do the best thing to make sure we get the exact exposure we want for our clients.
Until Next Time,
Chris Hugar, CFA