Episode: 51
Originally Aired: April 20, 2011
Topic: The Markets with Investment Manager, Dan Henderson
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:
- Introduction of Dan Henderson of Cookson Peirce
- Forecasting the Market’s Ups and Downs Is a Waste of Time
- Being Right the Second Time Is Much Harder Than the First
- Rebalancing a Portfolio Is Different from Market Timing
- Fear of Losing Money Leads to Reactions that Cost Money
- Monte Carlo Analysis Looks at Good and Bad in the Market
- Asset Allocation Looks for Rising Stocks in Falling Market
- Price of a Stock Reflects Daily Consensus of Supply and Demand
- Under 10% of Managers Outperform Their Benchmarks
- How Much Has Manager Invested in Securities He Recommends?
- Average Investor Made Under Half the S&P 500 over 20 Years
- Bonds Are Owned by Investor, So You Decide When To Sell
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
1. Introduction of Dan Henderson of Cookson Peirce
Nicole DeMartino: And welcome to The Lange Money Hour. Hello and welcome to The Lange Money Hour. We are talking smart money tonight with retirement and estate planning expert Jim Lange. He’s also the author of the best-selling book, the first and second edition of Retire Secure!, and his newest book, The Roth Revolution. Tonight, he is joined by Dan Henderson, president of Cookson Peirce, an investment management firm located in downtown Pittsburgh. We’re going to hear a lot about that tonight. Dan, thanks for joining us.
Dan Henderson: Thanks for having me.
Nicole DeMartino: Certainly! Tonight, Jim and Dan are going to be covering the plusses and minuses of trying to time the market, but before I turn it over to Jim, tonight’s show is live, so if you have any questions for Dan or Jim, please give us a call. The studio line is (412) 333-9385.
Jim Lange: Hi, there. Thanks so much for coming on the show, Dan.
Dan Henderson: Thanks.
Jim Lange: First of all, can we start with a couple of basic questions? What is market timing, and what is the difference between, let’s say, market timing on the market in general and market timing on individual securities?
Dan Henderson: That’s a great question, Jim. Market timing really is defined by getting in and out completely or partially out of the stock market itself; in other words, moving from either stocks to cash or stocks to bonds and making an active decision to either avoid or go into the market itself, whether that be the stock market or the bond market. Timing, as it relates to securities, is a different matter. We actually refer to it more as selection, not as timing. It’s done very purposefully based upon measurements that are put in place so that we can select the securities which we think are going to do best because we want to participate in the market itself. So, it’s really the vehicles you’re choosing, not the determination whether you’re going to be getting on the road with a vehicle or not.
Jim Lange: All right. Well, maybe let’s get back to market timing in general as in your first definition, which is getting in and out of the market. Now, I have a lot of clients who said, “You know, hey, back in 2008, I just didn’t feel good about the market, and it just didn’t make any sense to me, so I really went to cash.” And they attribute that decision to why they are not much worse off than they would be if they just left it in. How would you answer somebody like that who either has thought about doing that and didn’t and lost some money or somebody who actually did, and it turned out a little bit better?
2. Forecasting the Market’s Ups and Downs Is a Waste of Time
Dan Henderson: Well, actually, in the talk we put together, we use a quote from Peter Lynch, who’s a very famous money manager and he used to run a Magellan fund and is probably viewed as one of the best money managers ever, and his quote, and I’ll just quote it because I think it’s worth talking about, is “Attempting to forecast whether the market is at a peak or a valley, and whether to buy or unload stocks, as a result, is a waste of time.” I don’t know anyone who has been right more than once in a row, and I think that’s really the key to market timing, is if you attempt to market time, you’d have to be right twice. It’s not only the exit from the market, which some people did in panic in 2008 when the market began to correct, but even more importantly is the entry back into the market thereafter, and a lot of the individuals who exited the market and looked at that and patted themselves on the back, unfortunately, are still sitting on the sidelines in cash after the market’s already recovered 100 percent of its value from the low of March of ’09.
Jim Lange: Right, and then they end up actually being worse off. Let me ask you another question: What if you had a very simple market timing strategy? And I know that, let’s say, the general sense, “Oh, gee, I think the market’s overvalued” might be a little bit too flimsy, but what if you had something that said, “Well, I’m going to market time based on a price-earnings ratio, and if the price-earnings ratio gets to be too unfavorable, and it looks like we are just, in effect, buying what we think is too much on a hope and a prayer that we’re going to get out. But if it’s low enough, then we’re going to get in.” So, how would somebody who has done that … and I’ve actually read that people who had that simple model would actually outperform the S&P.
3. Being Right the Second Time Is Much Harder Than the First
Dan Henderson: Yeah, a lot of models work, first of all, so I’m not discounting the fact that there are timing mechanisms out there that you can utilize to maybe enhance the performance you may achieve of leaving in a buy-and-hold scenario portfolio. That’s not necessarily going to perform that way every single time. So, one of the big things, you’ll see disclaimers in our industry all the time, which is history has a tendency not to repeat itself, or past performance is not indicative of future results. That’s a very true statement. So, in one situation where a particular methodology for measurement may work, that may not repeat itself again in a meaningful way in the future. So again, you can be right once; it’s very hard to be right consistently again and again and again.
Jim Lange: Would you think that it’s almost an irrelevant question to say, “Hey, what do you think about the market right now?” Because the truth is, it’s just too hard to know one way or the other?
Dan Henderson: Well, it’s really driven by emotion, and I think the emotion and the media and a lot of other things blind people to what the ultimate goal is, which is achieving a certain rate of return that is necessary to provide a comfortable retirement in most cases, or a child’s education or whatever the goal might be, and losing sight of that in hopes to try to do better than what they’ve ultimately set out to do. One of the hardest discussions we had to have with a lot of clients, and I had to have it with my father, is that in March of ’09 when the market was at its bottom, was, well, we had a strategic allocation to put a certain percentage in bonds, taking that overweight position in bonds and literally forcing it into the market when everybody thought we were looking at the abyss. That’s really discipline. It’s not market timing. It’s having a strategic plan, and to be honest with you, the vast majority of the accounts that we manage that even had a 35 percent allocation to bonds and that we rebalanced at the market lows, are back to new highs.
Jim Lange: Well, actually, that’s a good point, and this might sound a little bit basic, but I think that this is a good thing for our listeners, could you distinguish between rebalancing a portfolio and market timing?
4. Rebalancing a Portfolio Is Different from Market Timing
Dan Henderson: Sure. If you have target allocation in a portfolio, just to make the math easy, let’s say it’s 65 percent in stocks and 35 percent in fixed income, we have a compliance that we follow and that we measure on a week-to-week basis, and that is if an asset class, bonds or stocks become more than 5 percent out of balance, we take an active approach of removing money from the overbalance position and moving it into the under balance position. By doing that, in essence, you’re forcing yourself to sell high and buy low. But what happens is, and there are statistics to prove this out, especially with mutual fund flows, the general investor does the exact opposite. The general investor gets out low because they give up and buy high where they’re buying a hot hand, only to repeat the mistake again and again and again.
Jim Lange: Yeah, I guess that’s kind of like the Nick Murray behavioral implications that … you know, I think he sometimes compares even the S&P versus people who invest in funds that are identical to the S&P, and the S&P always does a lot better, not necessarily because of fees — although that’s one issue — but because people, when the market’s miserable, they feel miserable and they get out, and when the market’s great, they feel good, they get in and they do exactly what they shouldn’t be, which is selling low and buying high.
Dan Henderson: Correct, and that behavior is very, very consistent through all bull markets and all bear markets. So, Fidelity did a great study on that recently and it showed that the flows into, as an example, stock funds, the market before the first crash in 2000 to 2001 when we had basically the Nasdaq bubble burst, the flows into those funds didn’t peak until a year beyond the fact that the funds peaked themselves. So, there were a lot of people that came late to the party, and the only experience they had was losing money when everybody else made money who came very early, and that’s very hard to do because we call that anchoring, and when a client has an anchoring experience, whether it’s a drop in the market in ’08 or whether their first investment went down, it has a tendency to resonate with them for an extremely long period of time, in most cases up to five years.
5. Fear of Losing Money Leads to Reactions That Cost Money
Jim Lange: And isn’t there also, to add to the worries or the issues of a regular client, that the fear of losing money and the way that the client thinks about losing money is over-weighted compared to the pleasure of making money, and therefore, people react in a way that they will end up with less money?
Dan Henderson: Right. It’s actually part of the risk profile that we do for every client, and that risk profile has a question and it’s not a loaded question. It’s actually two sides of a coin, and the way the question reads is ‘Are you most concerned about losing money? Are you more concerned about making money? Or is losing money and making money equally of the same concern?’ Every client wants to make as much money as they can and lose as little as possible. That’s just not a risk-reward trade-off that’s actually achievable. You have to take into consideration the amount of standard deviation associated with the portfolio or the asset class and know what you’re willing to bear both on the up and on the downside.
Jim Lange: Yeah, I know Jonathan Clemens, when he was on the show, and actually in his book, which is a wonderful little book. I think it’s called The Little Green Book of Money or something like that by Jonathan Clemens. He said that it is important to pick a particular strategy, whether it’s a 65/35 or whatever it is, and stick to that strategy, and that sticking to the strategy that you started with was actually more important than what you do in the meantime because, unfortunately, what happened … so let’s say that you ask that question to somebody and they say, “Well, yeah, I’m very interested in making money and I can handle some losses,” and then, in reality, they lose some money and they feel miserable and then they change their allocation, again …
Dan Henderson: They’re compounding their error.
Jim Lange: Yeah, they’re selling low and buying high.
Dan Henderson: Right, and that’s a common course of action and it’s more emotionally driven than it is rationally driven, and to your point, as you talked about with Clemens, it is true. The strategic allocation, which is the mixture between cash, fixed income and stocks or equities, determines about 80 percent of the portfolio’s productivity, and by market timing, you’re messing around with that 80 percent. So, the other 20 percent comes from selection, but the vast majority of the productivity of the portfolio is driven by that allocation.
Jim Lange: Yeah, that always blew me away, and I’ve heard similar statistics as quoted by Roger Ibbotson and other people that it’s really that base, and fortunately, or more realistically, unfortunately, I have a lot of clients and I think that it is part of the generation that probably both of us serve is that there is a huge aversion to loss, and people are very conservative, and when I do projections these days, I used to use 8 percent or 10 percent, and now, people even squawk if I use 6 percent. So, there’s a really conservative mindset set in. I don’t know if you’re having issues wrestling with that or whether you take people at their word and say, “OK, well, if 6 percent is OK with you, then we will invest accordingly.”
6. Monte Carlo Analysis Looks at Good and Bad in the Market
Dan Henderson: Yeah, you can assume whatever rate of return you like. We don’t want to look at longer rates of return to make those assumptions. Part of the planning process we go through is a Monte Carlo analysis, which basically takes in all of the good and the bad, all the different … you know, you can have a 20-year experience with zero return in the stock market, and you can have a 20-year experience with a 20 percent return in the stock market, and it basically puts you through about 5,000 different lifetimes and gives you an indication of what the probability of succeeding is, which is obviously, when you pass away, you do have some principle left. That’s, I think, a better analysis than what we did before in the past in the planning world where it was just a straight line appreciation based upon assumed rate of return, then throws in the variableness of those returns based upon the standard deviation and gives you, I believe, a clear probable outcome.
Jim Lange: Yeah, and we’ve actually had two programs in the past on safe withdrawal rates. We had Bill Bengen, who did the original work, and what he did, he did not use Monte Carlo. He actually used historic results.
Dan Henderson: Sure.
Jim Lange: And then we had Jeff Constantine, who probably did analysis closer to what you did, but the point that they were trying to drive home was how much money based on a percentage of your portfolio you could spend, and let’s just say that there was a wide range of between maybe 3 percent to 7 percent or 8 percent, depending on age and a number of other factors. What you’re saying is, you’re using some of the Monte Carlo to have probabilities of different outcomes with different investment choices. Is that right?
Dan Henderson: That’s correct because, obviously, if you have a lower standard deviation on return, you have a more predictable outcome, and having a more predictable outcome gives you a better model. That’s only achieved by adding a fixed income or cash into a portfolio to give it a little bit more stability than having an all-equity portfolio.
Jim Lange: All right. Well, presumably, you’re saying, “Yeah, there’s a few models that have worked in the past with market timing,” but generally, it sounds like you are not a market timer. But we do business together, and by the way, I should disclose that that you and I have a working relationship and that for certain clients that we do some of the work like Roth IRA conversion advice and estate planning advice, etc. and that you actually manage the money. But some of your techniques and, you know, you’re saying, “We do the math,” could that not arguably be market timing?
Dan Henderson: No. Market timing is getting in and out of the markets. That more has to do with security selection. The methodology that we use to select securities is quantitatively based, so we are measuring things, and then we, based upon the measurements, make decisions. So, that’s basically what it comes down to, and I can expound on that a little bit.
Jim Lange: I would like that, but this is probably a good time to take a break.
Nicole DeMartino: I’m giving Jim “The Look.” You can expound on that; we’ll be right back. You’re listening to The Lange Money Hour, Where Smart Money Talks.
BREAK ONE
Nicole DeMartino: Welcome back to The Lange Money Hour. We are here this evening with Jim Lange and Dan Henderson, president of Cookson Peirce, and we’re talking about the market.
Jim Lange: OK, Dan. Right before we started to take a break, you were distinguishing between market timing, and the market in general, and securities selection, and I know your big thing is, “We do the math.” And if you look at the credentials of the people who work at your firm, it doesn’t look like a bunch of financial guys. It looks like a bunch of engineers and quantitative types. So, I was wondering if you could … and I know that there are some proprietary secrets and that’s fair enough, but I thought maybe if you could say some of the things that you do, and how that isn’t really … you know, for example, they don’t ring a bell at the top, and they don’t ring a bell at the bottom. So, what is your method of selecting security, and is there anything other than market timing, other than, let’s say, “Well, no, we just do it on individual securities. We’re not getting in and out of the entire market, we’re just getting in and out of specific securities.”
7. Asset Allocation Looks for Rising Stocks in Falling Market
Dan Henderson: That’s a good question. There are a couple different schools of thought in our industry. One school of thought, and it’s used very widely, is a theory called asset allocation. The theory there is that you have asset classes which, in particular, will perform in alignment with each other, or they’ll perform differently from each other, which we refer to as correlation. We follow a methodology that leads us to the strength that’s in the market, and what I mean by that is whether the market’s going up or down, and down is probably more of a concern for most people than up, is there are stocks, even when the market’s going down, that are going up. So, that’s a given. So, you’ll never see a day that 10 out of 10 stocks, as a measurement, or 100 percent of securities in the stock market, are going down. When you do have those days, which we did experience a couple of them in ’08, that’s just outright panic. Normally, though, there will be stocks that are going up. So, the methodology that we use is pretty simple.
It takes a look at the universe of stocks in its totality and identifies those ones that are moving in a positive direction, relative to the universe itself, so that we can quickly identify what those stocks are and get in them as early as possible and ride them as long as they’re as profitable as they possibly can be. It’s just a mathematical formula that allows us to do that. It was developed by Bob Pierce back in the ’60s, on a slide rule, believe it or not, and he was from Carnegie Tech, not Carnegie Mellon. He put that together and then obviously it was done on calculators in the ’70s and computerized in the ’80s. But the measurements that we’re making, it is very similar to … you have two different schools of thought: One is fundamental analysis and the other is what we refer to as quantitative analysis. The fundamental analysis is trying to predict what’s going to happen in the future. So, you’ll see Goldman Sachs, Smith and Pinkeney, any big wire-house you like. They have a group of analysts, and that group of analysts looks under the hood of a stock, a company, see what it’s going to do, and they give an opinion of where that stock’s going to move to. So, that opinion could be it’s going to move to the same price it’s at right now by the end of the year. You could pick another analyst and they’ll say it’ll go up 20 percent from where it is right now. Another analyst will say it’s going to go down 10 percent from where it is right now. So, I equate that a lot to, like, forecasting the weather. You know, it’s a good guess, and one forecaster is correct. You know, so somebody says it’s going to rain, and somebody says it’s not, and one of the two is going to be correct, on any given day. So, you have to take a look and say, given that information, who is correct.
We don’t employ that type of methodology. We don’t guess. So, what we do instead is we walk outside, and if it’s sunny outside, then we know it’s not going to rain, and that’s basically what we do with the securities is we measure them from day one, and as we move forward, if it’s all sunny days, then we know we’re going to make a lot of money and profit from that stock. We’re never going to catch it at the bottom. Just, it’d be purely luck, because we have to see a trend emerge.
Jim Lange: Right, I was just going to say then, that you’re not going to be able to catch it at the very bottom, nor, would I assume, that you’ll get out at the very top. You’ll get out after it starts coming down some. Is that right?
Dan Henderson: Correct. That’s correct.
Jim Lange: So, it’s all really based on trend analysis.
Dan Henderson: That’s exactly the case. So, what we’re doing is, and we refer to it in our firm as relative strength, that what in essence we’re doing is finding out where the strength is in the market. So, when the market corrected and then we had to rebound, there were a couple of different sectors that were leaders, out of the gate: the consumer discretionary stocks, the technology stocks. The big leader out of the gate, which only lasted three months, was financial stocks. But it wasn’t a sustainable rally in financials. It plateaued, whereas the rest of the market continued to rise. But then we went through a period from like about March of 2010, about a year after the market was at its low, through about the end of August where the market trended downwards. And high dividends or high-yield stocks, like utilities, telecoms, consumer staples like Heinz and other companies that have high dividends, they did exceptionally well. So, those were the leaders in the market. And then we transitioned just recently back into another growth phase of the market where we started to see materials, industrials and commodity-related stocks, particularly energy stocks, which have led the market. So, the beauty of the analysis that we do is it allows us to identify what’s doing well in the market, and as we sell stocks, move into the new leadership to try to profit from it as long as possible, and then take our gains and move on to another sector that’s going to do well.
Jim Lange: So, does that mean that, let’s say, you know, a lot of times people think like when we’re talking 65/35 of stocks and bonds, and usually there’s a subdivision within that 65, there’s going to be a certain percentage of, say, large-cap and small-cap and mid-cap, and then even various sectors. So, is what you’re saying that you are doing both a combination of individual security selection and actually thinking about what sectors could possibly be going up and going down?
Dan Henderson: There’s two parts to that analysis. One is the individual securities, which then generates a ranking for the industry group or the sector. That’s also a part of the selection process. It allows us to identify sectors that are too hot, so we avoid buying into the trend, that if there’s a very strong trend, it may actually reverse quickly. But also, just equally as important is avoiding the bottom half, because no one knows what’s coming out of the basement. So, it’s almost like the Goldilocks theory: not too hot, not too cold, but we’re trying to buy the stuff that is going to go up at a measured pace and let our winners run, as long as it can be profitable for us. Our biggest position right now is up almost 500 percent from where we purchased it just a couple years ago, and it’s still doing well. But eventually, it will plateau, and to your point, it will peak and cross over, it will begin a downward trend, and we’ll want to get out as quickly as possible to take as many profits as we can.
Jim Lange: Well, it sounds like then, if there isn’t fundamental analysis, would you take into consideration what a company does, or is it more what the company’s numbers are?
8. Price of a Stock Reflects Daily Consensus of Supply and Demand
Dan Henderson: It actually has to do with the price of the stock itself because we view that as a pure measurement. It has all the fundamentals in it. It has all the trends in it. It has all the innuendos, all the discretions, everything’s in that number, because that number, which is decided upon every day, all day long, is a pure consensus of supply and demand, and if the supply is much lower than demand, then that price is going to move up, and vice versa. So, we believe that all the information you need to know about an industry’s security is in that price. But at the time when we select from the top of the buy list, there’s several stocks that are ranked similar to one another, and that’s when we’re going to look into what they do, you know, put more thinking behind the selection that we’re going to make for that particular given week.
Jim Lange: OK, so let’s say, for discussion’s sake, just something very common sense. Let’s say that there is an event, whether it’s in the Middle East or we drop some bombs on Libya, and there is, let’s say, the transportation at the Suez Canal is threatened, or something that would cause us to think, “Oh, gee, the price of oil is probably going to go up. But a lot of these oil companies have long-term contracts, the price is going to go up, they’re going to make a lot of money. Maybe I should get into oil companies.”
Dan Henderson: For us, in all honesty, that’s just noise. So, we don’t take into consideration that, other than if it affects the group of stocks all in a positive manner and we’re seeing them all moving in conjunction with one another. If that’s the case, then our ranking system will identify that, and we will then go in and select those securities. Because that’s not always the case. So, as an example, you know, we had the crisis in Japan, and all the devastation that happened over there, and the markets sold off very strongly for that period of time. And we actually have a methodology we use, we tend to refer to it as a power index, and all it does, it’s an oscillator that tells us if the market’s overbought or oversold. The reason we use that is for cash. So, if the market’s oversold, like it was after the events that occurred in the middle of March, then we will forcefully push cash in if we’re light in stocks at that period in time. Just like if we need to raise money for a particular client for spending or something else, if the market moves to an overbought level, we will aggressively take money out and put it into the cash component. That is more of a timing methodology, but it’s very, very short-term. It is no indication of what’s going to happen over the long run. So, the beauty of this system is that it allows us to look at a universe of about 1,200 securities to see what’s moving up and what’s moving down, trying to buy the things that are moving up and avoid the things that are going down. That’s the easiest way I can explain it.
Jim Lange: Well, let’s say some of our listeners, I don’t think we have too many listeners from Missouri, but let’s show me. A lot of people have interesting ideas. A lot of people write books and they sell books, and they have newsletters, and they tell you when to come in and get out. You’re obviously a full-service money manager. Many of your clients, or many of our clients, I should say, choose to use the combination of our services when we’re doing things like Roth IRA conversion, tax planning, estate planning, etc. But, just on the investment part, how have you guys done? And by the way, of course, past performance is no guarantee of future results. That’s a great caveat that I have to say.
Dan Henderson: That’s a mantra.
Jim Lange: But given that, has this strategy worked, or is it just a nice strategy, that you did almost as well as the S&P, and after your fee, a little bit worse?
Dan Henderson: Well, to keep in alignment with my compliance officer for this data, the actual rates of return for the primary equity strategy we’ve run, which started … our gifts compliant strategy, which is a standard that’s used for all performance measurement, started back in September 30th of ’01. Through that date, through the end of March of this current calendar year, March 31st of 2011, it’s averaged at 9.32 percent rate of return.
Jim Lange: Wait, 9.32 percent?
Dan Henderson: Right. That’s a gross rate of return.
Jim Lange: All right, so that’s not quite a decade.
Dan Henderson: No.
Jim Lange: But almost.
Dan Henderson: Almost a decade. So, about 9.32 percent gross rate of return. Over the same period of time, the S&P 500 has averaged about 4.59 percent.
Jim Lange: All right, so that’s more than five points better, and you said “gross.” Obviously, you’re not going to do the work for free. If I were in our client’s shoes, what I would want to say is, “OK, how have you done after subtracting your fee?” So, can you extrapolate what the results would be, after …
Dan Henderson: If you took out the highest fee that we would charge, in any of the management that we do, that would give us an excess performance figure of about 3.73 percent. So, we’re averaging … and we try to do this between 3 percent and 4 percent net better than the market. And a lot of people will say, “Well, that doesn’t seem like a lot.” But, I have to tell you very honestly, if you take that as an outperformance measurement over that period of time, you’ll find that from a domestic equity money manager, that puts you in the top one half of 1 percent, nationally.
Jim Lange: Well, that actually sounds killer, because a lot of times when people think about the last decade, they think, “Well, it’s basically been flat.” Or even the S&P, you’re now saying the S&P over that … I guess, again, it’s not exactly a decade …
Dan Henderson: No. Just one year short.
Jim Lange: Right, one year short. But you’re saying the S&P was 3 points …
Dan Henderson: 4.59 percent.
Jim Lange: All right, let’s round off and say 4.6 percent, which is maybe even a little bit better than people assume. I guess that’s partly because we had a very good year in 2009.
Dan Henderson: Absolutely.
Jim Lange: All right, and then you guys are how much better than that? Because the power of that compounding of even 3 percent over a 10-year period is enormous. If it were 7 percent, it would be doubling every 10 years.
9. Under 10% of Managers Outperform Their Benchmarks
Dan Henderson: Right. 7.2, rule of 72, you’re going to double your money every decade. You know, to be able to average a 9 percent rate of return for us, relative to that performance in the market, is exceptionally good. We believe that that’s what every money manager should bring to the table. The fact of the matter is that over a five-year period, and especially over a decade, the last statistic I looked at is less than 10 percent actually outperform the benchmark that they’ve measured themselves against.
Jim Lange: All right, so this “We do the math” stuff isn’t just really a slogan, it’s actually what you do, and it seems to be working very well for you.
Dan Henderson: It has in the past, and hopefully it will in the future.
Jim Lange: Yeah, and that’s in addition to all the service and everything else that you provide, and then if people choose to use the combination of our services, then it is the same fee to the end client, but then our office does … then we meet on an annual basis, when we do the reviews on our mutual clients, I don’t even talk about investments. I talk more about Roth IRA conversions and estate planning and overall goals and gifting, and that type of thing.
Dan Henderson: I think that’s the beauty of the partnership, to be honest with you, because I think the trend as of late has been to have providers that can be a jack-of-all-trades and an expert in none, or a specialist in none. I think that’s really a problem in the industry. I think that you should stick with what you’re good at and use experts for other things. While we have attorneys, as you know, on staff, we do not render estate advice. We have a lot of good relationships, like yourself, that we can advise people to go to, that that’s their area of expertise, and to your credit, very honestly. You know, being able to refer clients to good money managers, just not us, but others in particular, I think that also is giving them the best service, so that they can use the best type of money managers available to them in the local marketplace.
Jim Lange: Well, it’s kind of interesting, because I belong to a number of business groups that are actually in business, they give advisors help on how the advisor can do the best, and practically without exception, they all wanted me to become a money manager, because there was presumably more money in it. And I’m in front of many of these money managers all the time, and a lot of them I don’t think really add that much to the party. And they’re still, you know, they’re making a lot of money. And I thought, “Well gee, I really don’t want to become a mediocre money manager. I’d rather be a premier Roth IRA, estate planning, distribution planning expert, and then work with other companies, yourself and others like you mentioned, and let you guys do what you’re good at,” and frankly your 10-year, or, well, let’s say 9-point-whatever-percentage-year record is actually pretty astounding.
Dan Henderson: Thank you. We’re very proud of it.
Jim Lange: Yeah, and like you said, and accordingly, you’re not out telling people Roth IRA strategies and estate planning strategies and things like that, which I think is great.
Dan Henderson: Yeah, it works. That’s what you do, that’s not what we do.
Jim Lange: Yeah. All right, good. Oh, I am getting that look again!
Nicole DeMartino: I am always the mean one! We do have to take a break. We’ve been talking about performance, Cookson Peirce performance. Dan, are your fact sheets on your website if a listener wants to take a look at those? Or how can they learn a little bit more about that?
Dan Henderson: They’re actually not available on the website. If you go to the website, you can actually click on a button saying, “send me the numbers.” And then we’ll respond to that accordingly.
Nicole DeMartino: All righty. That’s www.cooksonpeirce.com?
Dan Henderson: Yes, but if you mistype it and misspell Peirce you’ll still end up at our website.
Nicole DeMartino: You’ll still end up at the website.
Dan Henderson: We own both of them.
Jim Lange: Good move!
Nicole DeMartino: www.cooksonpeirce.com if you want more information. We’ll be right back with The Lange Money Hour, Where Smart Money Talks.
BREAK TWO
Nicole DeMartino: Welcome back to The Lange Money Hour. We are here with Jim Lange and Dan Henderson of Cookson Peirce; he’s the president of Cookson Peirce. We’re talking about the market tonight, and just as a reminder, this show is actually chock full of really good information like a lot of our shows, and just to remind you, if you ever want to listen to our archives, we have all of our shows archived on www.paytaxeslater.com and we are on every Sunday at 9 a.m. This show will be replayed this Sunday coming up at 9 a.m., and then you will be able to hear it again on www.paytaxeslater.com.
Jim Lange: All right. By the way, a quick note on that. I don’t know any audio library that has more firepower, more good substance, than our own, and again, we’ve had some of the top experts. Jane Bryant Quinn has been on. Ed Slott has been on numerous times, Barry Picker, some of the really top IRA experts and Jonathan Clemens. There’s a wealth of information there and we don’t charge. Just go to www.paytaxeslater.com and you can listen whenever you want.
But anyway, back to Dan. Does your analysis also point to weaknesses, and is that ever an opportunity to sell short?
Dan Henderson: That’s actually a good question, Jim. And we have run what we refer to as a shortlist, for … the firm’s been in business 27 years now, we’ve never used it, and the simple fact of the matter is, and this is true of most money managers, if you’re very good at buying long-only equities, you’re very poor, normally, at selling short. So, we don’t leverage, nor do we hedge, any of the portfolios. We believe that by selecting securities and entering and exiting them at the right time, we can be profitable enough not to add what we consider to be another layer of risk associated with the selection process.
Jim Lange: Well, one of the things that I like about the way you guys do business is, you have a certain core philosophy, and you stick to it and it’s been very appropriate for you. Unlike, let’s say, some of our politicians who will switch, even on such core values as pro-life/pro-choice. To me, that’s not the kind of thing that you switch in the middle on. You just have certain core fundamental beliefs and a discipline, if you will, and you stick to that, which frankly … and sometimes, obviously in a much different way, in my own business, I have a certain, some might call it “pig-headed,” some might call it “visionary” or somewhere in between, a vision of the way I want to do things, and I just kind of plow ahead and do it, even if it’s not popular at the moment and even if you think, “Oh, man, there’s a really cool opportunity! Maybe this once, I’ll get away from my discipline!”
10. How Much Has Manager Invested in Securities He Recommends?
Dan Henderson: Yeah, that really comes down to what we refer to as replication of results. If you have a money manager in particular that changes their style or discipline, that basically negates all past performance. Because what got them there is something they’ve changed, and they’ve changed the core of what they do. So, it’s very unlikely they’re going to replicate their results on a going-forward basis. That’s something that we have been very disciplined about and never disengaging from, and so much so, that one thinks … a lot of people, I think, should ask their money managers, “How much of your own money is invested in your securities?”
Jim Lange: Well, OK, how much of your own money is invested in your own securities?
Dan Henderson: And I’ll tell you, on the principal level — it’s owned by three of us — 100 percent of our money is run by our firm. So, we don’t deviate in any way, shape, or form. In fact, we have four different strategies on the equity side that we run, and I have four different accounts in each of those strategies. Plus, we’re testing a strategy right now that both Bruce Miller, my chief investment officer, and myself have money in. So, we test it on our own money first, before we even do it with a client’s money. So, we literally eat our own cooking 100 percent of the time, and I think that any money manager out there should be able to say that, without reservation, because if they’re not, then really, what do they believe in what they’re doing? So, we’re happy with the numbers we have, we’re proud of the performance we’ve been able to achieve, and that’s why we invest money into it. Even our own money.
Jim Lange: All right. Well, one of the things that we have not talked about at all, and frankly it is one of the areas that I consider one of your strengths, is actually your bond department, and right now, there are a lot of people who are in a conservative “I don’t want to lose money” mode, and I know that, yes, today the interest rates are lower than they have been at other times, and yes, there is certainly risk in the bond market. But I do know that we have a number of mutual clients who have chosen to invest in bonds with you, and if you could tell our listeners a little bit about the way you select bonds, how that is or isn’t market timing, and if you typically use a laddered approach, and how you do that.
Dan Henderson: Yeah, it’s completely null and void of market timing. The fixed-income approach that we take, on the equity side, we add alpha, or we add our performance, so we’re actually trying to add money beyond the benchmark. On the fixed-income side, we’re trying to match the benchmark. So, we’re not taking an active approach to try to outperform the benchmark on the fixed income side. And the reality of it is, no money manager could do that well because of the nature of that particular marketplace. So, we took a different approach. We said, “If that’s going to be, in essence, your rock in a stream, or the protection of your principal, then let’s do it in the most conservative way we can, more conservative than most bank trust departments, by the way, buy high-quality, A or better, fixed income.” So, if there’s a credit risk, it remains investment-quality, instead of going down to junk, and put it in a passive ladder that’s usually going to be out to a decade old and have about six-month maturities throughout. Because by doing that, you’ll basically eliminate the interest-rate risk, and since you’re holding the bond to maturity, you’re going to return back the par value of the bond.
So, regardless what happens with the markets in between, because we know if interest rates go up, bond prices will go down, or vice-versa, it’s like a seesaw. That’s naturally the course of earning fixed income security. But if you hold it to maturity, you’re going to return back to your principal. The only time you will not have that happen is if there’s a default. The way we avoid that is trying to buy good companies. Not to say we’ve never had a default, because we’ve had…there were some financial stocks, Lehman, in particular, that we had a couple pieces of, that we had default. But outside of that, especially in the municipal side of the world, we use general obligation. And until recently, that wasn’t a popular thing. But in ‘08 and ‘09 when the stock market crashed, they became some of the hottest bonds out there. In fact, so much so, that the intermediate bond ladder, which is about a one- to 10-year ladder, performed, I think in 2008, was up about 15 percent.
Jim Lange: That’s out of sight, for bonds.
Dan Henderson: Right. So, it’s not a coincidence that all the money flowed to bond funds. And I just did this in a talk. We actually do a talk every once in a while, that I put on for individual investors at the request of people we do business with, which is, “Why market timing doesn’t work.” And what I share with them, and this is straight out of Morningstar and you can look it up online, is that in a calendar year, and this is one calendar year by the way, in the calendar year 2009, the market (remember, the stock market did 26 percent that year, after it rebounded).
Jim Lange: Wait, this is January to December.
Dan Henderson: January to December 2009.
Jim Lange: OK.
Dan Henderson: Bond funds, as a group, took in $357 billion in net new assets, which was more flows than they saw in the previous five years combined.
Jim Lange: So, the market’s doing great and people are running to bonds.
11. Average Investor Made Under Half the S&P 500 over 20 Years
Dan Henderson: Exactly, and it’s a statistic that has repeated itself again and again and again. In fact, there’s a firm out there, and you can look this up on the Internet, it’s called Dalbar, and they actually do, every year, year-in and year-out, it’s called the “quantitative analysis of investor behavior.” And they take a look at, based upon flows … to your point, you mentioned earlier about buying an index fund but not doing as well as the index? That’s because they try to time the market. Whether they did it purposefully, or whether they did it through panic, they didn’t do as well as the index. And what they do is they go out and take a look at that investor behavior and measure it, relative to the benchmark. So, the last data that they did ended in 2009, began in 1989, so you’re looking at 20 years history. Over that period of time, the Standard and Poor’s index, the benchmark did 8.19 percent return, annualized. The average investor, over that same period of time, did 3.17 percent.
Jim Lange: See, that’s incredible to me because so many people think that they are so good, and they are so afraid of paying 1 percent, or depending on how much they have, and I know with you, it could even be lower than 1 percent, and as a practical matter most people actually do much worse, is what you’re saying.
Dan Henderson: Yeah, it’s a statistical fact.
Jim Lange: I’ll tell you what I’d love to know is how the engineers are doing. I guess that’s not available.
Dan Henderson: It’s funny, though. The best clients are the ones that actually, from history, have been doing it for 20 years. The best are the ones that hire a professional and forget about it, and go enjoy doing something else in their life, because they have other, better things to do with their time, and let somebody else worry about it.
Jim Lange: And I’ve found that in my own situation, even in the area of Roth IRAs and estate plans. The people that try to outsmart us not only don’t spend their time doing what they could be doing otherwise, but they actually end up with a worse result than if they just said, “Hey, figure it out.”
Nicole DeMartino: Jim, I want to take one more break before the end of the show. You’re listening to The Lange Money Hour, Where Smart Money Talks.
BREAK THREE
Nicole DeMartino: Welcome back to The Lange Money Hour. We are here with Jim Lange and Dan Henderson.
Jim Lange: Coming back to the issue of bonds and the way you are doing it, so it sounds like you’re not trying to beat the market with bonds. That’s kind of your safety portion. How does that rate, let’s say, compare to a bond fund? And are there some advantages of owning individual bonds as opposed to … and I don’t want to get myself in trouble by mentioning specific bond funds, but going into the market and finding one of hundreds of available bond funds?
12. Bonds Are Owned by Investor, So You Decide When to Sell
Dan Henderson: Yeah, the big difference is you actually own the individual security itself. So, by doing that, you control the liquidation of that security. Normally, and you’ll see this happen, and it will happen again, when rates rise, you’ll see bond funds and the appreciation they’ve been able to achieve in the go-go years of ’08 and ’09 will begin to come down again, and in some cases come down quickly. We actually saw that happen at the end of last year. In the fourth quarter, the municipal bond index was down about 4 percent for the quarter, after obviously having a great year in 2009. When that happens, if you own a mutual fund, you don’t control that liquidation. In other words, you don’t control the consequences of emotional behavior by the peers that you’ve pooled your money within a fund. So, if a redemption request comes in, the bond money manager does not have a choice as to whether to hold that bond or not. They must liquidate in order to come up with the proceeds to meet the redemption request. So, that’s definitely going to be the case. Owning an individual bond, in an individual bond ladder, is much more passive, but at the same time, you control absolutely the liquidation that you have.
Jim Lange: And I guess, other than a default, you’re always going to get your money back, while a bond fund could actually go way down in value and then you’re just …
Dan Henderson: Sure.
Jim Lange: And then the thing that you did as your safety play ended up …
Dan Henderson: Costing you money, right.
Jim Lange: You know, we only have about three minutes, and there are a whole bunch of points I wanted to make. I know there was something that you wanted to talk about, in terms of some of the statistics that you had, so I think that if we only have three minutes, I’d better let you do that. The one thing that I will mention again, and I’ve said it twice, but I do want to say it one more time because I really like to run my business as an open book. We do have a relationship with Cookson Peirce and we share the same clients, and for the same fee that Cookson Peirce charges a client that would have nothing to do with me, we also add Roth analysis, estate planning analysis, many of the things that we’ve talked about on this show. So, I’m not completely independent of Cookson Peirce, so I thought I would say that. But with that caveat, maybe you could say a couple of the things that you thought were really, really important.
Dan Henderson: Well, you know, I think the subject of this was market timing, and I believe having gone through a 54 percent correction from peak to valley in the S&P recently, I think it’s still a very prevalent issue that a lot of people wrestle with. Those that exited are still wondering whether they should get back into the market. There are still trillions of dollars that are sitting on the sidelines waiting to get back into the market. We’ve seen a pretty consistent trend as of late, which is when a market sells off, it quickly recovers, and I’m not talking within a short period of time, but it happens within three or four days in some cases, but one of the things we’ve looked at in research is, and this is so true, panic, in other words, just getting out, it’s just simply not a good investment strategy. Standard and Poor’s did a little bit of a study. They looked at 30 years of investing history, back from 1979 to 2009, and they looked at the value of a thousand dollars. So, if you put it in the Standard and Poor’s 500 index, which you can’t buy, by the way. You can buy a similar type of investment. If you did nothing, it would be worth $24,000 right now. If you missed 10 months, it would be worth only $8,700. If you missed the top 20 months, it would be only worth $4,000. So, if that doesn’t tell you not to market time, I don’t know what else I could come up with that would make you believe that.
Jim Lange: That’s a pretty powerful argument.
Nicole DeMartino: And that’s a great note to end on. Dan, thank you so much for joining us.
Dan Henderson: Thank you.
Nicole DeMartino: If you want to have more information on Cookson Peirce and Dan Henderson himself, go to www.cooksonpeirce.com. If you want to talk more to us, www.paytaxeslater.com. This is Nicole DeMartino, Jim Lange and Dan Henderson, saying good night. You’ve been listening to The Lange Money Hour, Where Smart Money Talks.
END