BSW Chief Investment Officer David Wolf will be presenting at HUB Boulder on Local Investing, this coming Friday, February 8th from 10:30am to 12:30pm. David will be joined by Michael Brownlee, co-Founder of Localization Partners; and Kyle Heckmann, President of Flatirons Bank to discuss local investment opportunities including a fund targeting local food enterprises, community banking to support local businesses, and angel investing in Colorado start-ups . Please join us for a engaging morning of dialogue and idea sharing. Registration and event details may be found here!
To begin, our deepest gratitude and thanks from everyone at BSW to our clients, colleagues, and friends – it is a rare privilege to work with such truly outstanding people.
In the hustle, bustle and rush of the holiday season, it is often difficult (yet so very valuable) to maintain our perspective regarding the full richness of our lives. So to put things in context, reflect for a moment that the US’ 316 million citizens account for just 4.5% of the worldwide population of 7 billion people. Of those 316 million US citizens, roughly 5% have a net worth that exceeds $1 million. This translates to just two-tenths of one percent of the worldwide population, or one out of every 14 million people. We are indeed fortunate.
So in the coming weeks, let us strive to maintain an “attitude of gratitude” as we tend to the comings and goings of life. While navigating the holiday crowds, let us be grateful for the wonderful food and comforts for which we have both the access and means to enjoy; as we queue up for the poking, prodding, and herding of airport security, let us be grateful for the privilege of safe and speedy travel; and, finally, as we take stock of 2012 and look forward to 2013, let us be grateful for our precious lives – whose fleeting nature was underscored by last week’s tragic events in Connecticut – and the people who make these lives so special.
2012 Portfolio Review:
As of December 18, 2012, the BSW Diversified Growth Portfolio is up nearly 12% for the year. As a reminder, the Diversified Growth Portfolio has two components: Growth Equities and Alternative Assets. Growth Equities have posted a strong year thus far, gaining roughly 13% (including our disappointing Opportunistic trade in Apple, more on this below), while Alternative Assets returned a modest but respectable 5%.
- The Portfolio’s overweight to Emerging Markets was rewarded, specifically its allocation to Asia-focused, dividend-paying companies, which is the Portfolio’s top performer, returning 19% for the year. We continue to favor investments geared toward the rising Asian middle-class, as opposed to capital-intensive infrastructure projects.
- The Portfolio’s Small-cap and Mid-Cap allocations have each gained 16%, respectively, while its overweight to US Large Cap was beneficial, as large cap is also up more than 15% in 2012.
- Within Alternative Assets, High Yield Bonds were the top performer, returning 14.5%.
- Without a doubt the Portfolio’s most disappointing position was the Opportunistic buy of Apple. We initiated the position based upon a fundamental analysis of the company’s valuation and near-term earnings prospects. Unfortunately, a host of ancillary issues (most importantly a rush by nervous investors to lock-in gains prior to potential tax rate increases in 2013) took their toll on the stock, broke our stop-loss targets, and triggered an exit per our risk-management guidelines. While disappointing, the experience did confirm the wisdom of our limits (less than 5% portfolio weighting) on Opportunistic positions and clear-cut risk-management policies, while also underscoring the inherent volatility of individual stocks – particularly those of technology companies. One BSW client who served in executive roles for technology companies for 30 years noted to me that of the technology companies that were prominent when he began his career, only three remain (Apple, HP, and IBM) -- an incredible dynamic, on many levels. That said, BSW’s long-term track record on Opportunistic investments remains strong, we are not backing away from occasional Opportunistic investments, and we will continue to seek investments that meet our risk/return parameters.
- The allocation to Commodities within the Alternative Assets allocation was a poor performer in 2012, down 15% due to being on the wrong sides of trades in both corn (short) and soybeans (long). Although only a small (3%) allocation within the Growth Portfolio, we have been in regular correspondence with our Commodities manager and continue to have confidence that the position will ultimately add value -- but the manager is on a fairly short leash in 2013.
2012 Economic Commentary & 2013 Outlook
At the outset of 2012, we identified three key risks that global markets would need to contend with: 1) Europe; 2) US Fiscal Cliff; and 3) China. First, the Eurozone debt and banking crisis risked derailing the still-fledgling global economic recovery. Second, an inability of US legislators to meaningfully address the US fiscal cliff risked plunging the US (and the world) back into recession. Lastly, China risked a “hard landing” from slowing growth coupled with an important, once-in-a-decade leadership transition.
On the eve of 2013, while the US fiscal cliff risk continues to linger, the risk posed by Europe and China have somewhat abated. The European Troika (the European Central Bank, the European Commission, and the International Monetary Fund) successfully implemented an alphabet soup of programs designed to backstop individual countries, most notably through OMT (Outright Monetary Transactions), which is essentially a fancy way to say printing unlimited amounts of money to buy an unlimited amount of sovereign debt. And, just recently, Greek debt was just upgraded by six notches to a B-rating -- a tremendous improvement.
In this manner, the Troika has lifted a page from the US Federal Reserve’s playbook, as our own central bank just recently announced another round of Treasury buying to replace Operation Twist that will add roughly another $550 billion of debt to the Fed’s already gargantuan balance sheet. Between the Troika and the Fed, there is no doubt that we are living in the midst of the greatest monetary “experiment” in history. Thus far, the experiment has created a floor on downside risk – but has yet to create a self-sustained recovery or meaningful improvements in employment.
Meanwhile, China appears to have negotiated a “soft landing” and a functional, if uninspiring, status-quo leadership transition. Its economic indicators show marked improvement and China still has considerable latitude on a policy front. The country is no doubt slowing as it transitions from an export- and capital spending-driven economy to domestic consumption, but a more sustainable 6% to 7% growth trajectory now appears quite feasible.
Continuing with our theme of gratitude, in 2012 the global economy (and investors) caught a very lucky break. Any one of the three risk outlined above could have torpedoed markets – but they didn’t. So as we look ahead to 2013, while it is certainly critical to identify potential storm clouds on the horizon and what could go wrong, we also want to emphasize what could go right instead.
What Could Go Wrong:
- US Fiscal Cliff: a failure on this front could shave as much as 4% off of US GDP, plunging the US back into recession – along with the rest of the world.
- Paradox of Thrift: President Obama’s reelection increases the probability that Fed Chairman Bernanke will hold rates lower for longer, continuing a policy a financial repression that may actually be undermining growth. When all you have is a hammer, everything looks like a nail.
- Eurozone: the PIGS are still broke and austerity-induced unrest could unravel whatever consensus exists as leaders become tired of dealing with a slow burning crisis that will require many years to be resolved.
What Could Go Right:
- US Fiscal Cliff: angst over the fiscal cliff is acting as a huge wet blanket on the economy, markets, and investors. Although the cost of the expiration of the Bush Tax Cuts is widely known ($600 billion), BSW is convinced the “uncertainty tax” is orders of magnitude larger – and causing uncertain businesses to defer hiring, individuals to defer capital expenditures, and investors to stay on the sidelines. Based upon a variety of measures, investment markets appear to be a coiled spring, so successfully implementing a framework to address the US debt and providing a measure of certainty, even if it is not the fabled “grand compromise,” could enable both markets and the economy to make sustained forward progress.
- US Housing & US Energy: the unsung heroes of 2012 are housing and energy. The US housing market is showing signs of renewed life and stability, while the US is quietly on track to become the world’s largest oil producer within a few years and energy-independent within one or two decades. These two factors have profound implications for US growth, US debt (energy is the US’ largest negative in balance of trade), and local/state/federal tax receipts.
- Fed Policy Exit Strategy: If US can continue to muddle through and find viable footing, the Fed may be able to articulate a credible exit strategy from the aforementioned greatest monetary experiment in history. Doing so would allow the bond market to slowly digest rising rates and avoid the dangers from rapid inflation and an erosion in bond values.
Overweights & Underweights:
In terms of our portfolio overweights and underweights, we are now positioned as follows:
- US Large Cap: Slight Overweight (reduced mid-year)
- US Mid Cap: Neutral (valuations in-line)
- US Small Cap: Neutral (valuations in-line)
- Foreign Developed: Underweight (with a focus on dividends)
- Opportunistic: Neutral
- Emerging Markets: Overweight (with a focus on Asia and dividends)
- Commodities: Underweight
- High Yield: Overweight (spread-levels warrant caution)
- Precious Metals: Neutral
We hope this Commentary & Outlook provides you with better insight into your BSW Growth Portfolio and our 2013 economic and investment outlook. If you would like to discuss these positions or your portfolio in greater detail, please don’t hesitate to contact BSW. As always, we are happy to help.
Finally, as a reward for reading to the end of this post, please treat yourself to this excellent video montage of Alan Watts (here or click on photo below) on this post’s theme of Gratitude, as well as this wonderful and timely essay (here) by "Story of Stuff" author Annie Leonard – Happy Holidays and best regards!
BSW's CIO David Wolf will be presenting at the Rockies Venture Club's symposium on Impact Angel Investing, this coming Tuesday, December 11th from 5:30pm to 7:30pm at the law offices of Cooley LLP. David will be joined by Robert Fenwick-Smith of Aravaipa Ventures and Tyler Hartung of the Unreasonable Institute to discuss the intersection of philanthropy, supporting social and environmental impact companies; and investing in privately-held impact companies. Please join us for a engaging evening and dialogue. Registration and event details may be found here!
820 First Street, a.k.a. the CNN Building, sits across the street from Washington D.C.’s Union Station and has a commanding view of the Capitol Building only a few blocks away. BSW and its clients recently invested in this 298,000 square foot office building in partnership with Harbor Group.
Since the 2008 recession, the Washington market has been one of the few bright spots in commercial office real estate. 820 First Street in particular enjoys a unique location in a very attractive submarket of Washington within a block of Union Station, a major mass transit hub in the city and a site slated for extensive redevelopment.
Though the property is currently 99% leased, expiring leases will create an opportunity next year to remarket some of the space at higher prevailing rates. In a strong office market like Washington, this can meaningfully improve the performance of a building. Harbor Group will draw on its vast experience, resources and network to lease up this space.
If you followed the election coverage on CNN you more than likely saw the inside of this building. In 2012 the largest tenant, CNN completed the construction of its election coverage studio from where it broadcast election-day results. CNN leases several floors and has made extensive investment in suiting the space to their long-term needs.
BSW’s Elias Bachmann and Harbor Group’s Samuel Reichmann take over the CNN broadcast desk on a recent visit to the building.
-Elias Bachmann, Portfolio Manager
Russ Koesterich lunch – Colorado CFA Society
Why is the outlook for growth in the US and other developed markets so dim? And where in the world can we find growth? Russ Koesterich, Chief Investment Strategist at Blackrock iShares, provided some answers to these questions at a recent CFA (Chartered Financial Analysts) Society event in Denver. BSW portfolio manager Elias Bachmann, worked with the CFA Society of Colorado and Blackrock/iShares to bring Russ to this Denver event.
The Problem The US economy is generally expected to grow at a rate of 2% or less over the next three to five years, far below the 4% historical average. In Russ’ view this “uninspiring” recovery risks reaching “stall speed”, which like a weakened immune system, leaves the body susceptible to outside threats. He sees the fiscal cliff (http://en.wikipedia.org/wiki/United_States_fiscal_cliff ) as one of the primary forces threatening the US economy because the mandatory spending cuts and tax increases that follow will hit the US economy where it hurts the most: the consumer, whose immune system has also suffered from stagnating incomes and high debt levels. This toxic combo seems more likely given the lack of progress and resolution in Washington. Unfortunately, polls point to continued political division.
The Reason To provide some context for the slow growth problem Russ offered the three “Ds”. The first “D” deleveraging, addresses the ongoing process of reducing debt levels among private companies and consumers. Paying down debt seems reasonable, except that the cash-flow used to pay down debt would otherwise fuel investment and consumption. With absolute debt levels relative to disposable income still above historical averages, this deleveraging may continue for several years. The second “D”debt, refers to the absolute level of debt. While consumers and the private sector work towards paying down their liabilities, the Federal government continues to pile on more. The increasing burden of servicing this debt eventually reduces the government’s effectiveness at converting tax receipts into value-creating civic investments. Thirdly, “d”emographics remain a problem as more citizens begin to collect retirement related entitlement payments.
Diamonds in the Rough The US is by no means alone because the developed markets of Europe and Japan also suffer from high debt loads and aging populations. Nevertheless, Russ pointed out that this condition is not a foregone conclusion for all developed economies. Canada, Switzerland, Singapore, Australia, Norway and New Zealand have avoided this problem through greater debt discipline, have better demographics, and their stock markets trade at lower valuations, making them more attractive destinations for investment capital.
Emerging Opportunities While some developed markets offer opportunity, emerging markets continue to offer the best long-term growth prospects. In fact, Russ finds emerging markets particularly attractive due to four factors. First, after long periods of outperformance, emerging market stocks suffered due to the low growth expectations in the developed world. As a result, valuations of emerging market stocks are now below their long-term averages. Second, despite their long history of high inflation, emerging markets currently experience a modest rate of inflation. Third, lower inflation has a significantly more positive effect on profitability of emerging market companies than their developed market counterparts. It should be noted they are equally more vulnerable when inflation rises. Finally, the volatility of emerging stock markets has declined relative to that of developed stock markets. Remarkably, prices have not responded to reflect this more stable environment.
Insurance Central banks such as the Federal Reserve and the European Central Bank have demonstrated their itchy trigger finger for monetary easing as a defacto response to slow economic growth. We continue to search for conclusive evidence that this policy works. We believe it will eventually spur inflation. In the face of this money creation, currency debasement and the consequent inflation BSW agrees with Russ that gold should have a strategic role in any investment portfolio.
In summary, things don’t look good for mature economies because they generally have aging populations and debt levels that risk growing faster than their economies. Politicians are often loathe to vote for measures that curtail government spending, because the disappointment it brings jeopardizes their own jobs. However, given the paralysis in our government and the potential ride over the fiscal cliff, there are opportunities to position a portfolio with both long-term growth themes and insurance against foolish monetary policy.
-Elias Bachmann, Portfolio Manager
Figure 1: BSW's Elias Bachmann with Russ Koesterich
Today we sold our opportunistic placeholder position, the All-Cap World Index Fund (ACWI) and transitioned proceeds into Apple, which has fallen significantly (down 14% from late September) and following a (perceived) lackluster quarterly earnings report yesterday, Thursday, October 25th. We have followed Apple closely for quite some time (it is already a key holding in several of our fund positions) and our investment thesis is explained in more detail below. However, before discussing Apple further, a refresher on our methodology and process for Opportunistic positions may be helpful.
First, our internal benchmark for the Growth Equities component of the BSW Growth Portfolio is the MSCI All-Cap World Index. As such, the de-facto holding or proxy position for Opportunistic is ACWI – an exchange-traded fund that tracks the ACWI index. Any Opportunistic position (and the entire portfolio, actually) is continually evaluated and monitored relative to ACWI. For instance, if an Opportunistic holding gained 5% while ACWI concurrently fell by 5%, the Opportunistic position would have produced a 10% benefit versus the benchmark. So while the position itself was only up 5%, its net effect was +10% and it may actually trigger a sale (based upon relative performance metrics). In such a case, proceeds for the sale of the Opportunistic position would most likely be transitioned back to the benchmark placeholder (ACWI) – locking in gains (or losses) relative to the overall benchmark. This methodology provides two benefits: 1) Opportunistic positions are constantly tracked and evaluated to a specific target; and 2) It allows for nimbleness in trading as any sale proceeds may be immediately transitioned to the benchmark (eliminating the risks of going to cash, which is itself a “position” with an implicit stance toward the markets).
Now, on to Apple, that (again) was strictly being evaluated relative to ACWI. First, the recent decline in Apple was driven largely by Wall Street’s concern that Apple’s industry leading margins are weakening. While this is the case, it is consistent with Apple’s operating history when introducing new products (such as the new iPad Mini, iPhone 5, etc.). It takes time to scale and bring down production costs, but Apple has demonstrated its ability to do so and we believe the company can restore a point (or two) of margin once again. Second, Apple has worked to keep analysts’ expectations in-check and the company’s guidance points more to an inability to keep pace with demand than weakening sales. Third, with the introduction of the iPad Mini and enhancements to their existing product lines, Apple continues to outpace rivals like Samsung, Microsoft (the jury is out on Windows 8 . . .), Nokia, and RIM (aka Palm, RIP) – which will certainly translate into US holiday sales but also, and much more importantly, booming sales in China and the developing world (which are not accurately or adequately factored into current expectations).
Finally, the true crux and concern is quite simply, “Can Apple continue to innovate in the post-Steve Jobs era?) We believe it can – whether it be a music service to rival Pandora, a cable television-killing device, or something still completely off the radar (who honestly anticipated the iPhone? Or even the iPad?) While these longer-term considerations and interesting to debate, with regard to Apple as an Opportunistic position our stance and rationale is very straightforward and clear: We believe that Apple, at about $600 a share, growing at 25% to 30% per year while trading at about 13X projected 2013 earnings offers a compelling risk/reward opportunity relative to the MSCI All-Cap World Index.
We hope this update provides you with better insight into your portfolio and BSW’s process. If you have any questions or would like to discuss your portfolio in greater detail, please don’t hesitate to contact BSW.
-David Wolf, Chief Investment Officer
“Progress is man’s ability to complicate simplicity.” – Thor Heyerdahl
This intriguing quote was laminated to a chair in a coffee shop near Tabernash, Colorado, an unlikely place to find such a pearl of investment and life wisdom. Yet its sentiment rings true, particularly now, as we take stock of 2012 thus far, what lies ahead, and most importantly, the underlying purpose of our endeavors. BSW’s purpose is to make life better for our clients and staff – a simple, clear objective that reaches beyond the blunt tools of money and investments to the ideas, insights, resources and perspectives that enable you to avoid and eliminate complexity and live life to its fullest. To that end, this quarterly update will discuss our framework for the investment and financial markets in the coming years, along with actionable research on improving one’s happiness and quality of life.
BSW 4Q12 Positioning & 3Q12 Results:
The BSW Diversified Growth Portfolio has posted very strong returns in 2012, having gained 6% in the third quarter it is now up 11% Year-to-Date. The BSW Diversified Growth Portfolio is split into two buckets: Growth Equities and Alternative Strategies. Thus far in 2012, Growth Equities have been on a tear, up 12 %, while Alternative Strategies have returned a more subdued, but still respectable, 7%. Taking advantage of market highs, we rebalanced portfolios in mid-September, booked profits on our best performers (US Large Cap (+16% YTD) and, particularly, Large Cap Growth (+19% YTD)) and brought our overall US exposure closer to neutral. From our perspective, broad US equity valuations are now closer to fair value, though we have maintained our overweight to US Large Cap Growth.
Proceeds of these sales were used to modestly increase our EAFE allocation, a region to which we have been (fortunately) dramatically underweight for the past few years. We continue to maintain our overweight to the Emerging Markets with a focus on high-quality, consumer-oriented, dividend-paying companies – a strategy that has well rewarded (+16% YTD) and has greatly outperformed the broader emerging markets index.
Within Alternative Assets, we continue to like our positions in Gold (+13% YTD) and High-Yield (+11% YTD). In a world characterized by negative real yields and massive money-printing (more on these topics below), there is little opportunity cost (and attractive upside potential) in owning gold. Likewise, low corporate borrowing costs coupled with strong corporate profits give us confidence in high-yield bonds, while income-investors’ hunt for yield continues to boost prices – combining to produce good total returns. Our worst performer in the Growth Portfolio generally and Alternative Assets specifically has been our actively-managed Commodities position – which got caught on the wrong side of trades in both corn and wheat during this summer’s drought – and the position is under close scrutiny.
3Q12 Review, 4Q12 Outlook, & Forward-Looking Framework:
Global equity markets rallied in the third quarter following: 1) European Central Bank (ECB) President Mario Drahgi’s promise to “do whatever it takes” to defend the Euro and then backing up this bluster with the Outright Monetary Transactions plan to buy unlimited amounts of short-term sovereign debt; 2) The German constitutional court ratifying the $640 billion European Stability Mechanism government bailout fund; and, 3) The US Federal Reserve’s announcement of Quantitative Easing 3 (QE3), or as we call it, “QEternity,” and pledge to keep interest rates near zero until 2015.
Though seemingly complex, the actions of the ECB and the Fed are just more of the same money printing. Although a simple concept, money printing has profound implications for your investment portfolio, how to make sense of the likely future, and even your quality of life.
Consider that in 2007, it took $22,000 invested in a taxable money market earning 4.5% (the national average yield five years ago in October 2007) to generate $1,000 of taxable income. Today it would take $3.3 million invested in a taxable money market earning 0.03% (the national average now) to get that same $1,000. This is very troubling and very foreboding for several interconnected reasons which we call the Paradox of Thrift:
- As more and more baby-boomers enter retirement, they must necessarily shift their investments from growth toward income and capital preservation.
- By doing so, however, they increase demand for fixed income – which lowers yields further (yields move inversely to price).
- As rates of return decline, retirees are faced with three choices: a) Save and invest more money to get the same income (see illustration above); b) Work longer; and/or, c) Spend less.
- Unfortunately, each of these decisions offers dire consequences for the economy – the Paradox of Thrift, which goes something like this:
- If everyone saves more, consumption declines.
- If consumption declines, we need less stuff and fewer workers to make that stuff, resulting in slower growth and higher unemployment.
- This slower growth and higher unemployment prompts Central Banks (like the Fed and ECB) to lower interest rates (When all you have is a hammer, everything looks like a nail.) As rates go down (or stay down), the pattern is reinforced.
This dynamic has already played out in Japan, where an entire generation (the so-called “Lost Generation”) of young people has been saddled with entrenched unemployment and underemployment as older Japanese workers stayed on they job to bridge the income gap from low yields. (Incidentally, the yield on the 10-year Japanese government bond is a whopping 0.7% – 60% lower than US Treasury yields.)
Although the US is not yet trapped in the Paradox of Thrift, the signs and symptoms are worrisome: anemic GDP growth, record low yields, record amounts of cash holdings, and lingering unemployment (unemployment for persons younger than age 24 is more than 12 percent and for workers age 25-34 it is more than 8%) – not to mention the looming fiscal cliff and proposed tax increases on savings and investment.
While this may all seem terribly gloomy, that is certainly not its intention. Rather, the aim is simply to provide the backdrop and context necessary to be the chess player, not the chess piece. Helping simplify complex situations to enable informed and thoughtful decisions is one of the ways BSW strives to accomplish its purpose of making life better – as innumerable studies and evidence demonstrate that having a clear, established, and adaptable plan for the future is one of the clearest paths to success and contentment.
In this vein, pioneering Harvard researcher Sean Achor and colleagues have also identified five daily practices (Gratitude, Journaling, Exercise, Meditation, & Acts of Kindness) that have the largest potential for positive changes in happiness and well-being. So, as a reward for reading all the way to the end of the post, treat yourself to this short (~12 minute), outstanding, and insightful TED lecture on the Happiness Advantage.
We hope this summary provides you with better insight into your portfolio and BSW’s outlook. If you have any questions regarding our positioning or would like to discuss your portfolio in greater detail, please don’t hesitate to contact BSW.
-David Wolf, Chief Investment Officer
Sleep at 35,000 feet, breakfast in Orlando, lunch in Ft. Lauderdale and dinner in Miami; that’s only the first day of Portfolio Manager Elias Bachmann’s most recent property visit tour, which concluded its dizzying pace in Washington DC.
In 2008 the Florida apartment housing market suffered as home foreclosures and unemployment sky-rocketed. Three years later, the situation has changed dramatically as the average occupancy rate has climbed to 93% in Orlando and 95% in South Florida. Concessions such as the first month’s free rent are disappearing as apartment owners enjoy renewed pricing power, exemplified by a higher level of asking rents (fig1.). Harbor Group’s experience has verified these trends at our Florida properties where average occupancy has reached over 95%. “A rising tide of better fundamentals has been the key to our decision to invest in Florida” says Harbor Group’s Samuel Reichmann.
In addition to the improving fundamentals in the Florida market, Harbor has also been able to identify value-add opportunities like Sun Lake Gardens, one of our more recent investments in the Orlando area. When Harbor initially contracted to purchase this property, a substantial construction project on the property kept occupancy at 50%. Finalizing the acquisition took much longer than expected however, during this time, the seller completed construction and increased occupancy to over 80%. This effectively executed on much of the value add strategy Harbor had outlined and simultaneously rents benefited from an improving regional market. Harbor has since continued to invest in the property through interior upgrades and common area amenity improvements such as expanded fitness facilities and business centers.
The Villages of Morgan Metro in Landover, MD was originally intended to house active duty military personnel and is currently undergoing a phased transformation to traditional civilian housing. A new staging program has generated positive feedback as model units look occupied and creatively decorated. The multi-use trails on the 180acre property meander through forests and open space and give the property a park-like feel. An adjacent metro station allows residents to access alternative transportation to job centers in Washington DC and the surrounding areas.
Who knew an oversized closet could be marketed as a study room(figure 2)? But seeing is believing and this type of out of the box thinking is best appreciated in person. With visits we can see things that don’t come across in phone conversations or in investor presentations. And so I am happy to be the weary traveler, hitting the road to see for myself how our partners are managing portfolio properties. I hope they will begin considering beach locations in the near future!
Figure 2: Oversized closet converted to study room
-Elias Bachmann, Portfolio Manager
BSW is proud to host the Impact Angel Group's inaugural Social Impact Fund Showcase on September 7th, 2012 in our offices. The Impact Angel Group is an exciting new effort to create synergy and alignment within the Front Range's burgeoning angel and impact investor communities.
Per the Impact Angel Group's announcement:
Interested in making a difference and realizing a financial return? The impact investing industry is expected to reach over 500 billion in assets within the next decade and many innovative social impact funds are based right here in Colorado. Join the HUB Boulder, Impact Angel Group, Unreasonable Angels, Investor Avenue and Rockies Venture Club for a Social Impact Private Equity Fund Showcase. The event is open to accredited investors only and is expected to sell out.
Social Impact Fund Showcase
Date: Friday, September 7th, 2012
Time: 10:30am to 12:30pm
Location: BSW Wealth Partners, 2336, Pearl Street Boulder
REGISTER FOR EVENT (follow link to verify your accredited investor status and click on “Register for an Impact Investor Event/Event Series”)
Whether you are new to private equity investing or looking for more innovative ways to invest your capital, private equity funds can be a great way to diversify risk and reduce the time and energy required for angel investing. At this event, we’ll hear from Colorado-based clean tech, sustainable agriculture and general social impact funds, and discuss their opportunities.
Event is open to accredited investors only and is expected to sell out. There is no cost to attend. REGISTER FOR EVENT (follow link to verify your accredited investor status and click on “Register for an Impact Investor Event/Event Series”)
Booking Profits on REITs:
Today within the Alternative Strategies component of the BSW Growth Portfolio, we exited our REIT position and used proceeds to augment our allocation to high-yield bonds. REITs have been 2012’s best performing Growth Portfolio holding, having gained 14% through yesterday, nearly doubling the year-to-date return of the S&P 500 (+7.7%) -- and for which the average BSW client booked cumulative gains of +77%! That said, the compression in REIT yields, and their relative yield spread to both the equity market (as measured by the S&P 500) and 10 year US Treasuries, convinced us that the run-up in REITs may be getting long in the tooth. Our move out of REITs can be explained by three factors:
1. Following their price run up, REITs currently yield 2.8%, just 80 basis points more than the dividend yield on the S&P 500 (2%). We are quite cautious on REITs when their yield is less than 1% greater than the S&P 500, as REITs are typically prized for their income production.
2. With bond yields at historic lows, income-hungry investors have bid REITs up over the past few years, creating a worrying premium on REITs relative to equities.
3. Finally, as more investor money flowed into REITs, REIT managers needed to deploy that capital pushing the cap rates on newly acquired properties to troubling levels. Our experience and knowledge in Direct Real Estate was very useful here in evaluating REITs on their underlying, property-level metrics.
Augmenting High Yield:
As noted above, proceeds of our REIT sale were used to augment our high-yield bond position, which has returned 7% year-to-date and for which we are more confident on underlying fundamentals. Here’s a summary of our analysis and rationale on high yield:
1. Essentially, the corporate sector never fully bought into the recovery scenario and, as such, they have used the past three years to clean up their balance sheets and hoard cash. As a result, they are now holding historically high amounts of cash.
2. Corporate profits as a percentage of GDP also remain at historically high levels.
3. As a result of these two factors, combined with low rates (courtesy of the Fed), corporate default rates have fallen to nearly half of their historical average. Creating a dramatic historical divergence between defaults and the yield spread of high-yield to US Treasuries.
Going forward, we believe that even if revenue growth is slowing or stalling (the dynamic which has troubled the market in the current earnings reporting season), corporate earnings and margins are more than sufficient for them to continue making their debt payments. As such, the yield on our high-yield position (6.75%) and its underlying fundamentals are much more attractive to us from a risk/return perspective than REITs.
We hope this Portfolio Update provides you with better insight into your BSW Growth Portfolio. If you would like to discuss these positions or your portfolio in greater detail, please don’t hesitate to contact BSW. As always, we are happy to help.
-David Wolf, Chief Investment Officer & Managing Principal