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"CHA-CHA-CHANGES" ... Changes In The World Mean Changes Here at Private Client Group

As I sit here on another packed plane with David Bowie’s 1972 song Changes streaming through my iPod, I cannot help to feel the similarities in today’s world.  The current, political, economic and financial changes have been striking as in the song, “turn and face the strange, cha-cha-changes.”   This past spring many of you watched Greece riot over change.  Their country was on the verge of bankruptcy and without the monetary support of EU it would have had to file bankruptcy.  Meanwhile the capital building of Wisconsin looks similar as union workers are being asked to pay more of their benefits.  The unions’ have conceded to these terms but are unhappy that their future ability to negotiate contracts maybe reduced.  As for the Middle-east; I will quote someone much more qualified, Ret. General Colin Powell.  At the recent TD Ameritrade conference Gen. Powell said, “the Middle-east is a powder keg, in which people are trying to better the lives of their children and some of these changes may not be friendly to the United States.”   I can’t help to believe that is the basic human condition; betterment of self, family, community and hopefully spirituality is what drives the world.

Over the last 10 years I have been fortunate to meet people from all walks of life, through my various travels; sports figures, CEO’s, house wives, college students, doctors, professionals just to name a few.  I can verify that all of these individuals embody this human spirit.  What has been poignant during my last few travels is how people are talking about the “political economy” so freely, this has definitely CHANGED.  If you noticed I did not say the economy.  

Let me explain further with a little history.  Before the start of the 20^th century the word “economics” didn’t really exist as we know it.  Academics and market practitioners used to talk about “political economy, “which was the study of government and government policies and their impact on real economic factors of production.  So to some degree, the “state capitalism” of today is about the return of “political economy,” where the free hand of markets is taking somewhat of a back seat to the visible fist of government.  State capitalism is on the rise because balance sheet deleveraging in combination with structural imbalances are forcing markets to take that back seat.

To quote a great image from Mohamed El-Erian, PIMCO’s CEO and Co-CIO; “The world is on a journey to an unstable destination, through unfamiliar territory, on an uneven road and, critically, having already used its spare tire(s).”¹ The destination is a world that is re-regulated, de-levered and growing less rapidly in the industrial countries.  This is causing people to talk openly about money.  When I inform them of what I do people used to cower, but now there is a glit in their eyes as I discuss economic views of the market.  Whatever it is people I meet want to talk about markets and the economy.  A quick refresher course on economics 101:  the market and the economy can be on very different roads for a while, but normally they will merge.  So what does all this change mean to you and your ability to better yourself, family, loved ones and spirituality?  Well let’s address these in Three Parts: Change in the World, Changes at Private Client, LLC and Changes for You. 

 CHA-CHA-CHANGES IN THE WORLD.

As for the world, it has always been of personal interest, in fact Political Science was my major at Santa Clara University.  There is so much going on that an attempt to write it down in a concise manner would only assure a book longer than Leo Tolstoy’s, War and Peace.  So we are going to focus on the global macro, investment strategies and technology.  As for the global macro outlook we believe in PIMCO’s, New Normal hypothesis: one of muted growth overall, a protracted need for balance sheet rehabilitation, accelerated migration of growth and wealth dynamics to systematically important emerging economies and relatively weak global goverance.²  At PCG we rarely give market projections as truly no one knows.  Experience, global macro, technical trends and process are the key ingredients to the risk trade at PCG.  We use this information to adjust portfolio risk, for clients’ investments.  We think it is important to give an outlook because the last time we issued an outlook was the summer of 2007, 3 months before the markets receded.  Many investors feel better about their 401(k), IRA, Trust and other accounts, but we believe that risk to capital is high in many markets and sectors. 

There are 5 key reasons for this belief:

First, the extreme government intervention over the last 2 ¼ years has an ending date of 6.30.2011, unless QE3 is adopted.

Second, the rise in commodity prices will begin to drag on the consumer’s wallet, namely oil prices and the economic expansion will slow. 

Third, stock prices rise on two factors earnings and speculation of future earnings.  As the expectations of corporate earnings fail to reach their projected values prices will decrease to meet reality.

Fourth, the continuing deleveraging of consumer and corporate debt will drag global GDP’s. 

Fifth, the global printing of currencies will hamper global GDP’s.  This actuality will converge on stock price expectations and cause a downward pressure on traditional recovery models.

As per PIMCO – “for investors, this translates into a changing configuration of risk and returns – if you like, a world with a flatter distribution of potential outcomes, fatter tails and a baseline that is subject to unsettling dynamics of multiple equilibrims.”³

In understandable terms the return in the markets are going to more volatile and the upside over the longer term is going to below its historical norms.  Many firms, T.V. programs and web-sites are telling you it is business as usual, “see it always recovers,” well we believe this is not always true.  For those market historians the Nikkei, Japan’s major stock index hit 39,915 on 12/29/1989 and 9,755 as of 3/31/2011.  It is our belief that the larger financial advisory firms, broker/dealers, investment management and many firms within the financial industry are Modern Portfolio Theory(MPT)⁴ centric and this will present significant challenges through our secular horizon of 2015 and maybe further.  The primary reasons are three fold, their investment policy process has not been updated, their reliance on traditional or out dated data and technology, and lastly; the basic humanistic trait to resist change.  For this reason it is Private Client’s belief that the strategic approach to investment management will subject a portfolio to unacceptable risk and potentially damage a client’s ability to sustain their quality of life.  The use of traditional investment techniques may not reduce a clients’ quality of life if the client adjusts their spending habits or reduces the desired estate to their heirs downward.

CHA-CHA-CHANGES AT PRIVATE CLIENT, LLC (d.b.a. Private Client Group, PCG)

How have these changes affected PCG and do these changes have an effect on your investment.  PCG has adapted over the years for one main reason:  an attempt to improve client success within the changing financial world.  This change from traditional investment philosophy started to evolve 14 years ago in 1997.  Back then it became clear that our company needed to make adjustments in four key areas: personnel, services, technology, and investment process.  The investment products, services, and technology have become more robust since then and thus our process has gotten more sophisticated.   

PERSONAL CHA-CHA-CHANGES:
 

Timothy Moran, CMFC™, CFS, CAS, Founder/CEO – his responsibilities are to maintain company vision, product due diligence, investment design and client relationships.
 

Christopher Wilkinson, CFP™, AIF®, MBA, President/CIO – his responsibilities are to review product selection, investment policy, client relationships, and RIA compliance.
 

Kenneth Davis, CPA, CFP™, ChFC, CLU, Managing Partner – his responsibilities are to aid in the areas of risk management; i.e. Long-term care, Charitable giving, Life Insurance and Estate Planning.
 

Michael Hayes, Wealth Strategist – his responsibilities are to develop and maintain client relationships.  Client interviews, financial planning and wealth design.
 

Matthew Zienty, OSJ & Wealth Strategist – his responsibilities are to develop and maintain client relationships.  He also is to develop client communication events and FINRA compliance.
 

Angie Miller, Director of Client Relationships – her responsibilities are to maintain calendar, delegate service issues to other team members, trading, and to interface with clients on a daily basis.
 

Amy Burchett, Director of Client Services –her responsibilities are to handle client service issues, such as tracking down checks, following up on paperwork, change of address, registration changes, beneficiary changes and helping with insurance processing.
 

Tami Scailo, Client Communications – her responsibilities are to handle initial client paperwork, coordinate client events and assist the team with any pressing issues.
 

Ryan Thompson, Director of Technology Services – his responsibilities include client technology interfacing, reporting, client website support and financial planning. 

These individuals are here to work with you to help accomplish your individual goals.  These team members are caring, competent and experienced.  We have and will continue to establish mutually beneficial relationships.  A mutually beneficial relationship is an individual, family, business, endowment and/or organization that we feel we can help and in the process of providing value to them we are compensated.  I take full responsibility for any mixed messages on customized service solutions that PCG has provided in the past.  We are looking to systematize our services so that clients may experience a high degree of service.  An issue that keeps coming back up in interviews with clients is two: quantification of returns and service.  These are two highly individual concepts and if I asked 5 clients what the definitions for those two were; I would get answers as different as the fingers on your hand.  Going forward there is one matrix for verifying returns, did our clients have a return on capital and did Private Client significantly reduce the risk to capital in down markets.  Our returns are monitored weekly if not daily, but the investment plan that we establish individually for clients will be evaluated over a market cycle.

It is our belief that clients hire our firm because they wish to delegate the investment management or risk to a professional.  Similar to the relationship we share with other professionals; doctors, lawyers, accountants, etc.  Sometimes we are not afforded the same courtesy as these other professions, because of the high levels of stress that wealth demands and the increased access to information.  The truth is wealth is not accomplished in a quarter, year or 3 years, but long-term.  As the financial pornography from media sources grow the message that is perpetuating is this need for individual investors to do it themselves and understand everything.  Never before seen access to information has lulled persons into a belief that they can do it themselves.  The elephant in the room: that no one reveals to the investing public, is basic human behavior around money is very emotional. Let me share a story that may shed some light on this subject. I have a very successful friend who runs the second largest trading desk on the floor of the New York Stock Exchange.  He has been afforded the very best access to trading, up to the second information, 18 years of experience and wealth.  If you ask him what he does with his own money, his response will be, “I do not trade my own money, I leave that to someone I trust.  Because just I like everyone else in my booth; we do not behave properly when it comes to our own capital.”    I have included a chart which will help illustrate human behavior.

SERVICE CHA-CHA-CHANGES:

We hope that we are your trusted advisor.  Private Client is consistently vetting many new services and reviewing investment techniques.  Our office hours are changing from 9:30a to 5:00p for clients.  This is for two primary reasons, our team is comprised of parents and this will allow us the crucial time to spend with our children before school.  The opening hours of the market are beneficial to monitor positions, review current allocations and execute any needed changes.   This means that phones will be answered by a team member between those hours, unless all lines are busy, please leave a message. 

Private Client is establishing available appointment times:

of course if an exception is needed we will work with those individuals. As for clients whom live out of town we are establishing webinar meetings this quarter.

Our fee schedule will be reduced affective July 1^st, 2011 and we will continue to charge forward quarterly.  This new fee schedule was designed after we reviewed our 2010 profit and loss statement and the technology improvements PCG has experienced with Schwab.  Our fees are based upon household assets and are not tiered as many other firms offer.  If your current fee is lower, Private Client will not change your advisory fee higher.  All new advisory fee agreements will be coming to you through the 2^nd quarter for you to review.

In order to help our clients get the information that they desire.  We are setting a series of Fundamental Fridays, where clients and guest can come together to discuss and learn.  These events will be a must attend events.  We are also increasing our communication to monthly market updates, quarterly reviews, more frequent client contact through e-mail, in-person calls and annual appointment calendar with each client individually.  Please help us get the appropriate information we need to service your needs as we will be performing e-mail based as well as phone based questionnaires with each of you.

TECHNOLOGY and INVESTMENT CHA-CHA-CHANGES:

In the words of the great Jedi Master Yoda, “You must unlearn what you have learned”.  It is important to understand that PCG’s investment process changed away from Modern Portfolio Theory in 1997.  It was our instinct that this theory could subject too much risk to individual clients’ portfolios.  We initial incorporated 25% of our models to tactical and other hedging strategies.   We are now expanding this to allocation to a maximum of 75%.  Our proprietary software has made it possible for us to examine portfolios for their True Diversification™.  This allows us to review portfolios in a never been seen before dimension. 

This process has four key components:

·       Risk adjusted growth and reduce tail risk⁵

·       More meaningful diversification than traditional approaches

·       Portfolio design must be more adaptive in different economic environments

·       Our goal is to improve the risk/return characteristics of our clients’ portfolios, by either enhancing return, reducing risk or both.

Unfortunately, everyone knows there is a problem both domestically and globally, but no one wants to talk about it.  This problem in our opinion is enormous debt, both consumer and governmental and governments seems to stretching austerity balloon to capacity.  The fact is; promised benefits to many within this great Nation and other industrialized nations are not attainable.  What I like to refer to as the Ostrich Maneuver will no longer cut it.  This is the maneuver that many ignore and just continue to go about their lives and the hope is if we keep our heads down it will all blow over.  Well, I have news for every man and woman in the Senator, Congress, Governor, State Legislator, City Counsel and citizen, it  will not work or we will make Greece look like a sparrow belching in a Hurricane.

In conclusion:

CHA-CHA-CHANGES IN WORLD

The previous models of global market returns will not meet the historical mean rates of return.  The probability of global growth expanding at normal rates will probably diminish as global balance sheets are bloated with debt.  Emerging markets will be much more important in global economic dynamics.  The global markets will continue to increase their correlation characteristics with each other.  This places a modern approach to diversification techniques.

CHANGES AT PCG

Private Client Group, is changing its service model through technology and enhanced staffing for improved communication and hopefully a better client experience.  Individual companies offer a greater opportunity in the “New Normal” over systematically challenged mutual funds.  Although they do offer more unsystemic risk, the positives outweigh the negatives.  Our proprietary “N3 Strategies” will continue to be reviewed on a weekly basis and individual managers will be employed for their expertise.

Analysis of all portfolio design will reprioritize semi-variance and semi-correlation over standard deviation and beta.⁶

CHANGES IN OUTLOOK

We believe the U.S. is perhaps the best positioned of the global economies to withdraw its public support.

Government bonds will underperform for the next 5 to 10 years

Emerging market’s debt instruments look more attractive than “industrialized nations”.  Emerging market equities also look to outperform more debt ridden economies.

In the latter half of 2011, we will likely see signs that inflation is gathering momentum

Merger and Acquisition activity is likely to be area of heightened activity, as US companies are lean and looking for ways to create more profits and synergies.

Sincerely,

Timothy Moran, CMFC, CFS, CAS		Christopher Wilkinson, CFP™, AIF©
Founder/Chief Executive Officer(CEO)		President/Chief Investment Officer (CIO)

Footnotes

¹ Pimco 2010 Outlook

² New Normal -

³ Mohamed El-Erian, Co-CEO of Pimco in the 2010 Outlook

⁴ Modern Portfolio Theory - is a theory of investment which attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. Although MPT is widely used in practice in the financial industry and several of its creators won a Nobel memorial prize for the theory, in recent years the basic assumptions of MPT have been widely challenged by fields such as behavioral economics.

⁵ Tail Risk - A form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution.

⁶ Definitions of Portfolio Measurement are from Investopedia.com

            Semivariance - A measure of the dispersion of all observations that fall below the mean or target value of a data set. Semivariance is an average of the squared deviations of values that are less than the mean.             Correlation - measures the degree of association between two random variables, with the effect of a set of controlling random variables removed.

            Standard Deviation - In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.

            Beta - A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected   return of an asset based on its beta and expected market returns.