Woodstock Quarterly Newsletter / Q4 2018
Keep Calm and Carry On in US Public Equity Markets
Here is a headline that you would not expect to see. Proudly for most Woodstock clients it shows how smart you are. “In the gloom that hung over the financial world in 2008, it would have been difficult to imagine US stocks were poised to embark on their longest bull run in history.”
As the article points out the 2000 tech bubble bursting was still recent history, we were in a time of sharply falling stock prices, and yet from September 15, 2008 (the day Lehman Brothers failed) to September 15, 2018 the S&P500 is up approximately 200% and many Woodstock accounts have traveled a similar path. Some differences depend on client withdrawal rates, but even here growth of equities has tended to more than offset those withdrawals.
Now what? Analysis shows the US stock market to be fairly valued. What are the alternatives to keeping doing what we have been doing? A rising interest rate environment could negatively affect all financial asset classes, but it will, particularly, negatively affect valuations mainly tied to interest or dividend income return.
The second unexpected headline is “hedge funds nearing a bad 10-year streak”. The “smartest” people in the investment world were said to run the high fee, high return hedge funds. The article points to 18 different hedge fund strategies with none of the strategies beating the S&P500 over 5 years, 3 years or even 1 year and the average return being approximately 1/3rd of the S&P500 return for those periods. The recent closure of some big name hedge funds (meaning they return invested funds to their clients and become private entities, in some cases, or go completely out of business in others) is another set of surprising headlines.
Only one of those 18 strategies is “emerging markets”. The next unexpected headline is that “emerging market returns beat developed market returns as long as the US is left out”! The article relates investor confidence, leading to investment in emerging markets in the 2000s, to “central banks being given independence, democracy taking root, trade booming and foreign exchange buffers being built up to counter capital flight risk”. While this process might not be “in reverse” everywhere, it has been counteracted by “autocratic governance” in enough places to cause concern.
How confident are we in US public equity markets? Against a back drop of challenges to public equity markets by private assets and public corporate debt, how do public equity markets stack up? “The market value of all US stocks is higher than ever at more than $30 trillion.” This compares to “$6 trillion of high grade US corporate bonds at face value and about $5 trillion for all private assets under management globally”. Public equity markets are still the most important game in town. At this point in time who would expect US stocks to be the place to invest? We would.
Where has discussion of the fiduciary standard, as applied to investment professionals (banks, insurance companies, broker/dealers and investment advisers) gone awry? While we believe that the Investment Adviser Association’s (“IAA”) understanding is correct that “most investors don’t know that only investment advisers are bound by the fiduciary standard and (those investors) don’t know how to distinguish different types of financial professionals from one another. The IAA solution is to raise the standards for broker/dealers.
In our opinion this effort risks diluting the legal standard embodied in the 75 year old Investment Adviser Act, although it can’t change the fiduciary standard embodied in Common Law which is hundreds of years old and continuously evolving. It fell to a second October opinion piece to set the stage correctly. The Securities and Exchange Commission’s (“SEC”) proposed best interest standard (Regulation Best Interest, or “Reg BI”) is “exactly the same as the current ‘suitability’ standard. Nothing substantive (is) going to change”; “it is certainly misleading to give this same standard a new name and suggest that brokerage firm representatives actually had to act in the ‘best interest’ of their customers”.
Now that’s a strong opinion. Backed up by the insight that the brokerage service model, commissioned brokers and zero sum oriented firms, is “essentially predatory”. This commentator suggests that the key disclosure that should be made by the SEC is that the investing public has a choice between taking advice from a “predator” (a broker/dealer) or a “guide” (an investment adviser).
Of course, this obviously frustrated author dramatically overstates the issue. In many ways the financial services industry is intertwined. For example, we rely on brokerage firms for research, however, we believe we have the best “product” in the industry (individually managed accounts). We believe clients are best served by entering the financial services industry through an investment management firm and Woodstock is the best you could choose.
We know that you are the most valuable business development tool that we have. Your referral of a friend, colleague or family member to us is the most important way that we grow.
We thank you for your support and want you to know that we are dedicated to serving your best interest.
William H. Darling, Chairman & President and Adrian G. Davies, Executive Vice President
 WSJ 10/1/18
 Factset historical price earnings ratio comparison, 10/12/18
 WSJ 9/10/18
 WSJ 8/10/18, 10/4/18,10/5/18
 WSJ 8/14/18
 WSJ 8/13/18
 Definition: an advisor must act in the best interests of its clients and not favor its own interests over those of its clients.
 IAA newsletter, October 2018
 Financial Planning, October 2018