MITCHELL E. KAUFFMAN
Registered Rep.: Your production increased almost 50 percent in 2008 over the prior year. How did you accomplish this?
Mitchell Kauffman: I don't know that there is one magic answer. One part of it is our investment philosophy. For a number of years, we embraced a model where we used downside protection to allow us to potentially do well when the markets are up, but have some kind of a protection on a lump sum basis, or a cash flow basis, should the markets go down. For example, in the late 1990s, equities and indexed annuities were a part of it, so we were locking in market profits then. When the markets started tumbling in 2000 and 2002, we were still locked in at 1999 levels. So we had lump sums that were available at 1999 levels. For clients who didn't need the money, we could invest it at 2002 levels. Then 2003 and 2004 came along, and everything shot up and we had a leverage effect. This time around, because interest rates weren't that attractive, we used variable annuities with living benefits, and FDIC insured structured notes, instead.
RR: What measures did you take last year to prepare for the downturn?
MK: When we saw the markets start to unravel in 2007, we were constantly on the phone with clients to make sure they were sufficiently protected so that they could sleep at night. For a number of them, that meant increasing exposure to variable annuities and structured notes. We were also very fortunate to have a number of structured notes that were commodity based. In 2008 we had a number that had doubled in value in three years, and we fortuitously looked at those and said, ”Let's not be greedy, let's take some of this off the table.” Right afterwards, during the summer of 2008, the price of oil fell so we moved some clients into other types of structured notes. We moved other clients, depending on their cash flow needs, into CDs or different types of variable annuities. I tell clients when you're in the middle of something like this it looks like it is never going to end. So in the late 1990s, we had the tech bubble, and it looked like the roads were paved with gold as far as the eye could see; then we got into the real estate bubble, commodity bubble, and now we're in a different kind of bubble. We're in a panic bubble, where everyone is afraid to own things; like the rest of them, this will pass.
RR: What are some essential challenges you see yourself (and other advisors) facing right now? How do you plan on overcoming them?
MK: One of the challenges is that people are overwhelmed, particularly prospective clients. Like ostriches with their heads in the sand, they don't want to look at what is going on. But now is the time to get proactive and look at how your clients are positioned. If investors are sitting on the sidelines in cash waiting until they hear good employment news, they need to realize unemployment is a lagging indicator and they're going to miss the rebound.
FIRM: Raymond James Financial Services
CITY: Pasadena, California
YEARS AS A REP: 26
YEARS WITH CURRENT FIRM: 21
PRODUCT MIX: Roughly 50% variable annuities, 25% mutual funds, 20% managed accounts, 5% other (insurance, individual securities)
YEAR-END 2007 AUM: $90 million
YEAR-END 2008 AUM: $95 million
END OF Q2 2009 AUM: $105 million
SPECIALTY: Comprehensive wealth planning and management with an emphasis on retirement planning.
Registered Rep.: When exactly did you start to see that the market was going to change — for the worse — and that you would have to take measures to prepare for the downturn?
Shane Brisbin: I've got to tell you, I saw it late probably along with a lot of the other people, but I think the difference is, I communicated what was happening in the market very regularly to clients. We didn't sound all alarms and say ‘sell all equities.’ However it did get worse than we thought.
RR: So what steps did you take?
SB: Our philosophy is, you don't want to have a portfolio that forces you to have to sell equities at an inopportune time. We had assets in cash and fixed income and could take advantage of some of the opportunities the market sent our way. For instance, in December and January, we started shifting assets from cash and fixed income to high yield municipal bonds and investment grade corporate bonds. One of our best asset classes so far this year is bank loan funds, which are up 20-plus percent versus the equity market, which is flatish on the year. The same with high yield municipal bonds. So we shifted assets and tactically allocated.
RR: Do you use traditional asset allocation strategies and modeling? If not, what do you use?
RR: Models didn't work last year. We have an asset allocation strategy with a thematic approach overlay. We tactically adjust portfolios based on themes. My theme now is: Why get overinvested in equities when you can earn equity-like returns in debt asset classes, like high yield munis, bank loans, investment grade corporate and credit opportunities. Along with that, you can't have a sustained equity recovery unless you have sustained credit recovery, so we're seeing a lot of opportunities in credit. The second theme is, go where the growth is, so equity allocations go towards the areas of the world that have growth. We do have an overweight in emerging markets. The third theme is, over the long term, we're going to have inflation in the things that are important, such as food, agriculture, fertilizer, essential commodities, and deflation in things that aren't important such as big houses, vacation homes, etc.
RR: How did these themes change from 2008 to now?
RR: We've actually been reducing our investment grade municipal bond exposure in California and making it more national. We're also adding to the other credit themes, so we reduced our exposure, but added other credit sectors to fulfill our fixed income allocation. Right now we're starting to pull back a little from investment grade corporates, and we may pull back all together. We were not invested at all in investment grade corporate over a year ago. We had zero exposure, but now we have a lot more.
RR: How do you think this market compares with others you've seen in your career, say in 2000 to 2002?
RR: There are two major differences between this downturn and the downturn in 2000 and 2002. First, in 2000 to 2002, the crash was caused by a lot of our clients' companies, which then looked to financial services firms to save them. In this downturn, it was the financial services firms that caused the crash, so we were part of the problem, and our credibility as an industry was shot to a large degree. The other main difference was that there were places to hide in 2000 and 2002. Small cap value did well; munis did well; real estate funds did well; many hedge funds did just fine. But in this downturn, correlations went to one.
FIRM: Morgan Stanley Smith Barney
CITY: San Francisco
YEARS AS A REP: 15
YEARS WITH CURRENT FIRM: 7 (legacy Smith Barney)
PRODUCT MIX: Managed accounts: 50%; cash and bonds: 25%; alternative investments amd others: 25%
YEAR-END 2007 AUM: $1.8 billion
YEAR-END 2008 AUM: $1.4 billion
END OF Q2 2009 AUM: $1.5 billion
SPECIALTY: Ultra high-net-worth wealth advisory.
Registered Rep.: When exactly did you start to see that the market was going to change (for the worse) and that you would have to take measures to prepare for the downturn?
John McClure: I was a real bear in the fourth quarter of 2007. I am counter-crowd in the way I run my business and manage money because the herd instincts will run you off a cliff. We try to make decisions every day about where we think risks are in the market. We're a risk management firm.
RR: So how did your core investment strategy change?
JM: We have multiple asset classes in each portfolio, so we trade government bonds, high yield bonds, US dollar, equity sectors, precious metals, oil and gas, international exposure and major U.S. indices. We try to make money in every asset class, regardless of the direction of the market, so we're very quick to adjust as conditions change. When the market fell everything dropped like a safe, and the only way to protect against that is to the hedge the portfolio and take short positions on the asset classes. We were short equities in the fall. We're starting to get short again right now. These themes change on an intermediate term basis. It depends on the asset class you're trading. Really it depends on how reverted to the mean some of these things got. If they got extremely high and then fell out bed and went multiple standard deviations, we took advantage of that. Those are tremendous opportunities to make profits because risk is low and the reward is high. I think our performance over that time period shows we did a pretty good job.
RR: What was your performance?
JM: We were up for the year in 2008 in two [model] portfolios and down slightly in two others. We made gains in 2008 and in 2009. The way we do business, the direction of the market really has no bearing on our returns. We're not a traditional manager; we're an absolute return manager.
RR: How has the industry changed?
JM: What the industry is facing is that even if you have $1 million, you still have an underfunded retirement, and most people don't have that, especially after ten years of losses. So investors need to make equity-like returns, but they can only stand fixed-income risk: They need to have their cake and eat it too. There is no way to do that except with absolute return. You can't produce equity-like returns with lower volatility unless you're active in your approach. I would encourage leadership to embrace absolute return strategies, and look to the people who have been doing it for years. People are beating up on Harvard and Yale endowments. They lost 30 percent, but they made so much money in the prior 15 years when everyone else lost money. This is a blip on their radar screen. You need to allocate a sizeable portion of your assets to absolute return strategies, and I would argue the older the investor the bigger the allocation should be.
FIRM: ProfitScore Capital Management, Inc.
CITY: Eagle, Idaho
YEARS AS A REP: 7
YEARS WITH CURRENT FIRM: 7
PRODUCT MIX: Managed accounts (100%)
YEAR-END 2007 AUM: $11.2 million*
YEAR-END 2008 AUM: $18.7 million*
END OF Q2 2009 AUM: $30.4 million*
SPECIALTY: Generating absolute returns for high-net-worth individuals, institutions, hedge funds, and other investment advisors.
*Third-party management and/or subadvisory for other firms accounted for roughly 47 percent of McClure's assets under management in 2007 and 2008, and 51 percent in 2009.