The Best Protection From Risk Is Price

Sometimes I will speak with investors who question owning an asset class.  The best example I can use now is European stocks.  Their claim is that Europe is a complete mess (unsustainable debts, socialistic policies, unmotivated workers, recession worries and inept politicians).  All of their claims are true, and because of all these issues, they don’t want to invest in this particular asset class.  My response is typically the same.  I ask them if they believe there is any value to these European stocks .  When they look at companies like Nestle, BP, and Novartis, all will say that of course there is some value to these companies.  So then my follow up question is, at what price do these companies become compelling to buy?

All too often, investors hear a narrative about a sector of the market and want to avoid it at all costs.  They forget that even the worst areas of the markets are worth something, and they forget about one of the most important aspects of investing:  price.  One of the best protections from risk is buying at a low prices.  You tend to find the best values in the most unloved areas of the markets (right now it is European and Emerging Market stocks).  When you look back at major collapses in asset classes it is because investors forgot about this truth.  No one worried about price when they were buying tech stocks in 1999, real estate in 2005, or mortgage backed securities in 2007. 

While purchasing undervalued securities takes courage (it requires you to buy something that has lost a lot of value), countless studies show that these “value” stocks tend to be the best performers over longer periods of time.

The Disruptive Force In The Financial Advisory Business

I like to look at numbers and trends, especially when it has to do with the financial advisory business.  That is why I was particularly excited to review the data found in Financial Advisor Magazine’s eighth annual RIA Survey.  For those of you unfamiliar with financial advisor lingo, RIA stands for “Registered Investment Advisor”.  These are firms that are not allowed to collect commissions to sell products and must act in their client’s best interest at all times.

This survey reviewed 522 firms across the country, which managed about $607 billion in assets at the end of 2012.  This was an 18.7% increase over the prior year.  Just for fun, I decided to look at the major wirehouse firms who employ thousands of brokers (these are firms that still receive a big chunk of their revenue from selling products for a commission) for comparison purposes.  Below are the asset growth numbers for those firms during the same period:

  • Morgan Stanley: 8.5%
  • Merrill Lynch/Bank of America: 7%
  • UBS: 9.2%

This is what a disruptive force looks like.  There are a number of small firms that are growing and taking market share from the big boys at an alarming pace.  I have listed a few reasons why I think this is happening:

  1. Focus on sales- having worked at a major wirehouse before Greenspring, I can tell you the culture at those firms is polar opposite to RIA firms.  Discussions around the water cooler at a wirehouse all have to do with individual brokers.  What are you doing in production?  How much did she bring in assets last quarter?  What’s working for you right now to bring in new clients?  Conversely, if you were a fly on the wall in an RIA office, you would hear conversations about clients.  How can I get this client to save more in taxes?  Should we consider doing a Roth IRA conversion?  All the warm and fuzzy commercials and ads can not change the fact that the culture of RIA firms are just more focused on clients while wirehouse firms are focused on individual broker’s sales.
  2. Too many clients- while not one of the wirehouse firms discloses how many clients their advisors work with, the number is typically pretty high.  Less than ten years ago, the number was somwhere around 400 clients per advisor.  While I think this number has dropped recently, it is still very high, making it difficult to do any meaningful planning work for clients.  Conversely, RIA firm surveys typically range about 50 clients per advisor, giving this segment of the market a huge time advantage to work with clients.
  3. More appealing model-  wirehouse firms still derive a large portion of their revenue from selling products to clients.  The new clients that come to Greenspring from those firms tell us they were unsure the products that were sold to them were really the best for them or if their broker just had to make their own mortgage payment that month.  RIA firms have a model that is more pure, with 100% of their revenue coming directly from their clients, nothing from product sales.  We have found clients are just more comfortable knowing that they are paying for advice rather than getting sold a product.  

This trend is not new.  It has been happening for years and not only are clients defecting, so are advisors.  Thankfully, for client’s sake, we only expect to see this trend accelerate in the years ahead.

Earnings Are Beating Low Expectations

We are right in the middle of earnings season and the Bespoke Investment blog has a good chart of earnings beat rates compared to the last several years.

As you can see, earnings have beaten expectations at the rate of 71%.  While earnings look great from this perspective, it is a little bit misleading.  Estimates for earnings have been coming down over the past year.  Consider that at the end of the second quarter of 2012, the estimates were for earnings to be about 8% higher than their current levels today.  What does this mean?  Analysts have been lowering their projections, catching up with the slowdown occurring in corporate earnings.

The good news is that for the full year 2013, earnings expectations have stopped falling and have stabilized.  Earnings expectations are one of the big drivers of stock market performance, so this is welcomed news.  About 60% of the companies in the S&P 500 have reported earnings this quarter…we’ll check back in with some more statistics on how these companies are doing once earnings season is complete.

Innovation The Key To Growth

I recently came across a wonderful story that reminded me that every great business begins with an individual (or group of individuals) who have an idea, an appetite for risk and the ability to access capital (either their own or from others).

A former MBA student at MIT, Hyungsoo Kim came up with the idea when a fellow classmate who was visually impaired asked him what time it was during class, even though he had a watch on.  After class, Kim asked the student about the watch he was wearing and learned that it audibly sounded the time.  However, the student said it was embarrassing and disruptive to use, especially when in class, during meetings, etc.  As a result, Kim came up with the idea to create a watch (or rather “timepiece”) called the Bradley that allows a person to tell time by touch rather than sight by using a simple ball-bearing mechanism.  The watch case has raised hour markers on the dial combined with a ball bearing on top and on the side that allows you to feel the minutes and hours. The ball bearings travel around the case with the help of magnets.  

The Bradley

Interestingly, Kim has raised capital for Eone through Kickstarter, a well-known crowdsourcing platform.  Originally looking to raise $40,000, Eone has raised more than $310,000 with the help of more than 2,000 backers in a little more than a week!  I think the lesson is that we live in a time of tremendous opportunity for those individuals and businesses who continue to innovate and take risks.  The combination of these two things will drive growth and sustainable economic recovery.

Making the story even more powerful was where the name of the timepiece came from.  Lt. Brad Snyder lost his sight from an IED explosion in Afghanistan in 2011 and and went on to capture two gold medals and a silver at the 2012 Paralympics in London.  You can learn more about the incredible story of Brad Snyder and Eone here.  


Why Destruction Is Necessary In A Thriving Economy

It is truly fascinating to watch a dynamic economy evolve over time…a constant battle between creation and destruction.  Most people love the creation part but hate the destruction.  Unfortunately, it is necessary for healthy growth.  Let’s take the last recession as an example.  Thousands of jobs were lost that were related to the real estate industry.  There was a massive glut of building that took place over several years that needed to be unwound.  This painful process caused job losses, bankruptcies and disruption in ancillary businesses.  Realtors, mortgage brokers, architects and construction professionals saw job losses or income reduction.  As this area of the economy was no longer offering attractive returns, capital (both financial and human) flowed elsewhere, like the healthcare industry.

It is this cleansing that allows our dynamic economy to recover so quickly.  Imagine if companies could not fire unnecessary employees.  There would have been more bankruptcies, company losses, and a longer recovery cycle.  It is with this backdrop that I was so pleased to read this article today:’s Emmy Storms reports the Chicago Association of Realtors added 600 new members this spring, at a rate of 75 to 100 enrolled each month.

Meanwhile, Miami Association of Realtors vice president Lynda Fernandez says there’s been a 25% increase in the growth rate for new members, from to 3,800 YOY from June 2012 to this year, compared with 3,000 for June 2011-June 2012. She said only a small percentage were likely to be transfers from other associations.

Real estate is finally coming back, and with it, new jobs are being created.  Free markets work.  We may not be happy with some of the byproducts (recessions), but throughout history, this economic model has created more wealth and increases in standard of living than anything we could ever imagine.

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.