Winter 2011 Newsletter - Business Owners

84 South Fourth Street Columbus, OH 43215

Mark Fissel, RFC Clint Edgington, CFA

www.BeaconHillAdvisory.com

The Wealth Managers for Business

Business Wealth Management Process TM

This Quarter: Cash Flow Planning

This quarter’s activity, planning for future cash flow needs, can be a powerful tool in prepar-

ing for your future. With a proper roadmap, we find that anxiety decreases and allows you

to focus your efforts. Cash flow planning can address future needs ranging from retirement

plan contributions to potential business liability decisions such as payroll and bonus obliga-

tions. Though planning can require an initial time commitment from the client, future ad-

justments can easily be made with our model to allow for dynamic adjustments.

Next Quarter: Estate & Legacy

Cash Flow and Retirement

Retirement and College Planning

Liability Driven Investments (payroll, bonus payments, etc.)

Corporate Retirement Plan

We’ll likely find out that U.S. GDP

rose about 2.8% for the year once

final numbers are out. Although

not a fast growth rate, we didn’t

have the “double dip” recession

that many experts predicted and

most were concerned about. Euro-

pean sovereign debt issues made

investors jittery in the summer, and

we continue to feel tremors due to

those shocks. Corporate profits in-

creased briskly, with large compa-

nies stockpiling record cash bal-

ances rather than hiring. Unem-

ployment has dropped slowly, but

remains stubbornly high at 9.8%.

While it’s said that econo-

mists and analysts make

predictions in order to give

weathermen something to

laugh at, a solid review of

where we came from is neces-

sary in order to focus on the fu-

ture. We laughably create mac-

roeconomic projections down to

the tenth of a percentage point,

and the only promise we make

to our investors are that none of

them will be completely accu-

rate. Although our past predic-

tions have not all come to light,

the process of creating projec-

tions and identifying areas of

concern brings significant value

to our processes and our clients’ portfo-

lios. Success is only measured by our port-

folios’ performance and, more impor-

tantly, in helping our clients meet their life

goals.

Just as Mama Bear’s porridge was “just

right”, the U.S. economy grew enough in

2010 to bring stability and profits, but not

enough to make central bankers turn off

the spigot of liquidity. This rising tide

lifted all risky asset classes in 2010.


Economic Summary- Goldilocks Brings Investors A Great 2010

The Wealth Managers for Business Owners

Winter 2011 Newsletter

84 South Fourth Street Columbus, OH 43215

P: 614.469.4685

[email protected]


In This Issue:

2010 Economic Summary 1

Equity Market Recap 2 Fixed Income Recap 3 Alternatives Recap 4 Upcoming Events 7 Wealth Mgmt Process 8

We have seen signs that they are beginning to put

cash to use through investments, acquisitions, divi-

dends, share buybacks, and dipping their toe in the

hiring waters.

We tend to agree with the majority of the pundits

that are predicting a bullish equity market in 2011.

Individual investors have finally started moving

money back into the equity markets from fixed

income, with equity investors injecting $42B net

new money into the equity markets in Q4, and we

see this trend continuing. This, coupled with com-

panies beginning to invest, acquire and hire cre-

ates a virtuous cycle. We are, however, never con-

fident in our ability to find the next bubble (and

there will be one) and the resulting pop. With

volatility at a low point, we will be discussing with

our clients the value of market insurance while

skies are blue and costs are low.

www.BeaconHillAdvisory.com pg. 2

The equity markets enjoyed a tail-

wind of low valuations at the beginning

of the year due to jitters over a double dip

recession.

Equity markets rallied in the beginning of the

year due to healthy economic indicators.

The optimism faded during the summer as

bondholders became concerned Greece and

other European Union members would not

be able to fund their fiscal commitments and

still pay their bondholders. As expected, the

bondholders demanded higher rates to con-

tinue holding their debts, and higher rates

on a country’s debt only makes the funding

problem worse, a classic Catch 22.

Stronger members of the European Union stepped

in and backstopped debt, and continue to do so as

issues surface. Equities then climbed a “wall of

worry” in the 3rd

Quarter of the year, and had a

great 4th

quarter due to robust holiday sales. Spe-

cifically, smaller company stocks continued their

outperformance over larger stocks for the third

straight year.

An interesting divergence between economic

growth amongst different regions and the perform-

ance of stock markets cropped up in 2010. While

the U.S.’s economic growth was lackluster, our

stock markets outperformed most developing

countries’ stock.

How can this be? Valuation. The rampant predic-

tions of a double dip at the beginning of 2010 kept

U.S. stock valuations compressed. Corporate prof-

its rose very briskly and rewarded those whom in-

vested in U.S. stocks. Corporations responded to

the scare of market stress and the dislocation of

the capital markets in 2008 and 2009 very logically

by hoarding cash.

Equity Markets — Low valuations were our friend

1

Eric Kurjan is the president and owner of the Six Disciplines

NWO. He is certified on the Six Disciplines methodology and

is responsible for coaching and offering strategic advisory

services to both large and small companies. Prior to joining Six Disciplines, Kurjan was the president of

Plumbline Solutions, Inc., a 75-person start-up software consulting company. Plumbline was formed as a

spin-off from Microsoft in August 2004. Prior to Plumbline, Kurjan was general manager of the North

American professional services organization for Microsoft Corp. As general manager, he led a team of

more than 500. He earned his bachelor’s degree from Miami (Ohio) University. Kurjan currently serves

on the board of trustees of, Blanchard Valley Health System, Plumbline Solutions, Inc. and is the current

president of the Board of the Findlay Country Club. Kurjan and his wife, Lisa, and their two daughters, Madeline and Anna, live

in Findlay, Ohio.


Upcoming Event:

Business Owner Strategy Session - B.O.S.S. ™

Are You Ready for 2011? Build a Strategic Plan & Produce Results

In one hour, learn;

• How to build an effective Strategic Plan

• How to execute the plan

• How to achieve the goals you set

___________________________________________________________________

MORE at www.BOSSworkshops.com ___________________________________________________________________

Attendees will receive;

• 1 FREE hour | one-on-one consulting in Feb.

• A complimentary Business Health Index

Wednesday, January 19th | 12:00 PM – 1:15 PM

RSVP at 614-469-4685

Ohio Employee Ownership Center

Special Thanks to our Sponsors:

Event Speaker: Eric Kurjan


Commodities and Currencies (cont’d from page 5)

We do, however, question the wisdom of following the

crowds headlong into gold. Unlike many investments,

you can’t be a little bit wrong in a gold trade and make

money. For example, if our fixed income investments

face tailwinds this year, and interest rates jump up 1%,

we likely will not lose any money as our interest will

offset the amount our bonds will go down. If you are

wrong with gold you lose money. We too, are nervous

about the Federal Reserve printing massive amounts

of money. However, we choose to invest in profit gen-

erating enterprises that are not denominated in U.S.

dollars, therefore giving us a cushion in case we are a

little wrong and the U.S. Dollar rises.

1. Injected into conventional mutual funds and ETFs http://www.lipperweb.com/Handlers/GetReport.ashx?reportId=4150 Free registration required

2. http://www.lipperweb.com/Handlers/GetReport.ashx?reportId=4143 Free registration required

3. Many have concerns about the municipal markets now, however, that market is too localized and fragmented to be included in this brief review. 4. With a typical minimum investment of $1M, a diversified Private Equity portfolio of 10 investments, with Private Equity/Venture being 5% of a portfo-lio this would require a $200M portfolio.

5.Gold is included in the “Metals” Index, but we have broken it out for the readers convenience.

6. There are many one sided arguments for the value of gold. For a fascinating, balanced, philosophical discussion on the value of gold, see http://

www.oaktreecapital.com/MemoTree/All%20That%20Glitters%2012_17_10.pdf GDP info: Bureau of Economic Analysis

Unemployment data: U.S. Bureau of Labor Statistics

Currencies

Likely surprising to most is that the U.S. Dollar appreci-

ated slightly against a broad basket of other currencies

in 2010. Concerns about the Fed’s liquidity actions

and the spending of the U.S. Government in general

were offset by our economic growth. True to the ad-

age that “The Dollar is the worst currency, except for

all the others”, the dollar was buoyed by the E.U.’s

Euro and U.K.’s Pound Sterling’s depreciation due to

their fiscal issues. Most Asian economies strength-

ened.

We tend not to maintain a significant outlook on cur-

rencies, although we do position our portfolios to hold

non U.S. Dollar denominated assets.

Benchmarks for 2010 review

Equity Market “Large U.S. Companies”- S&P 500 Total Return

“Small U.S. Companies”- Russell 2000 Total Return “Foreign Developed”- MSCI Europe, Austrialia, Far East Total U.S. Dollar return

“Foreign Emerging”- MSCI Emerging Markets Total U.S. Dollar return

Fixed Income “U.S. Aggregate Bond”- BarCap U.S. Agg. Bond Total Return

“U.S. High Yield Bond”-BarCap U.S. High Yield Bonds “Foreign Developed”-BarCap Global Aggregate Bond ex-U.S. U.S. Dollar return, unhedged, Total Return

“Foreign Emerging”- JP Morgan Emerging Bonds Plus U.S. Dollar return, unhedged

Alternatives “Short Bias”- DJ Credit Suisse Short Bias Hedge Fund

“Market Neutral”- DJ Credit Suisse Market Neutral Hedge Fund “Long/Short”-DJ Credit Suisse Market Neutral Hedge Fund “Event Driven”- DJ Credit Suisse Event Driven Hedge Fund

“Global Macro”-DJ Global Macro Hedge Fund “Venture Capital”-Cambridge U.S. Venture Capital

“Private Equity”-Cambridge U.S. Private Equity “REITS”-FTSE NAREIT All Equity

“Private Commercial”-NCREIF Property Index

Alternatives II “Agriculture”-Roger’s International Commodity-Agricultural

“Energy”-Roger’s International Commodity-Energy “Metals”-Morningstar Metals Commodity Total Return

“Gold”-spot price in U.S. dollars

We believe many of the tailwinds bonds enjoyed in 2010 will turn to headwinds in 2011. They will cer-

tainly no longer provide the boost that they did.

Our concerns are:

• Individual investors will move out of fixed income when the appetite for equities returns, which

has begun. Individual investors were net redeemers of bond funds in November for the first time

in a year2.

• Economic growth will increase the return investors demand for fixed income, which will decrease

prices.

• Many of the “levers” that sovereign governments pull to keep rates low have been exhausted.

Keep in mind that a shock to high quality bonds will not result in near the losses from a shock to equi-

ties. Therefore, there is still value to having a fixed income component to buffer our more conservative

investors, and to “keep powder dry” for our more aggressive investors during the inevitable rainy day.

We foresee continuing to earn our return (and take our risk) on the credit side rather than through in-

terest rate risk.

As you can see in the graph, the last quarter of

2010 was difficult for the fixed income market due

to concerns over Quantitative Easing 2 described

above. This reaction should not be shocking, in

fact, we have been surprised it has not yet hap-

pened. What is startling was the speed and depth

of the reaction.


Fixed Income - Money kept pouring in

Still scared from the Great Recession of

2008, individual investors that missed the

2009 run-up poured cash into fixed in-

come, to the tune of $236B through November

searching for yield on their assets. The Fed, nerv-

ous of a double dip recession, continued its cam-

paign to keep interest rates low. Only in No-

vember when they announced the purchase

of another $600B in treasuries (“Quantitative

Easing 2”) did bondholders get concerned

over the Federal Reserve paying the federal

debt by printing money and the spurring infla-

tion. As inflation hurts the value of their

bonds, they responded by demanding higher

rates, which increased interest rates along

most maturities.

Consistent with risk being rewarded, high

yield bonds (“junk”) outperformed the overall

market. Europe’s sovereign debt issues held

down foreign developed bonds while Emerg-

ing market bonds appreciated due to currency

appreciation and rapid economic growth.

2

3


Hedge Funds (Equity based only)

Equity based hedge fund managers had diffi-

culty adding value due to high correlations

among stocks. Hedge fund index returns should be

viewed skeptically from a data perspective for reasons

too lengthy and boring to discuss in this brief review

(i.e. survivorship bias).

Short Bias hedge funds bet against stocks by

“shorting” stocks them. They had an uphill battle dur-

ing a year when equities increasing by double digits.

Market Neutral funds have approximately the same

amount of “long” exposure (owning a stock) as they do

in short exposure. They only provide returns when the

manager successfully determines stock winners and

losers. As most stocks were winners in 2010 that was

a difficult proposition and we can see that they did not

succeed as a group. Long/Short mutual funds tend to

be net long, but also have short positions. They strug-

gled to provide returns as well, although their larger

long bias helped. These three categories performance

is not exciting and, in effect, investors simply got what

we would have predicted based on how much long

exposure they had.

Event driven hedge funds attempt to profit

from mispricing of securities due to specific

events. An example is share class arbitrage,

which is shorting expensive classes of a

company while buying the cheaper class of

the same company- hoping for the gap to

close. Assuming that their return was

somewhat independent of general asset

returns, they may have added value.

Surprisingly, Global Macro funds, which

scour the globe to look for mispricing in all

asset classes (equities, currencies, com-

modities) did not yield compelling returns.

In a year with rising asset classes worldwide, and their

usual comfort getting into commodities (which had a

great year), we would not have expected such low re-

turns.

We continue to research hedge funds and like the con-

cept of Event Driven hedge funds and certain fixed

income hedge funds (which we did not review here).

However, we can’t justify our clients paying the typical

fee structure of 2% of Assets plus 20% of all gains for

what has historically been middling returns. We do

not hold hedge funds in the vast majority of our port-

folios and do not foresee including them in the near

future.

Private Funding

Private Equity and Venture Capital do appear to have

rebounded well in 2010. Many data issues also occur

with private funding, and these index returns should

also be taken with a grain of salt. However, this data is

somewhat stale (as it always is for PE and Venture)

and the ending date is 6/2010. Economic conditions

and activity have improved since then, so it is probable

that this understates performance considerably.

Hedge Funds, Private Equity, and Real Estate- Worth the costs?

Commodities and Currencies- Global Growth lights a fire under commodities

Commodities

Commodities benefitted generally from

expectations of renewed global growth,

and specifically from emerging markets (Brazil,

India, and China especially) requiring signifi-

cant resources to continue building their infra-

structure and satisfying their emerging middle

class populations.

The majority of Metals have risen because

they are an input to production and China’s

export restrictions on certain “rare earth”

metals caused prices to spike. Gold, however,

has risen as investors have become nervous of

worldwide currency devaluations.

We keep a commodity investment in our portfolios to

act as a hedge. We do not foresee maintaining a large

position. In the long term, commodities do not bring a

lot of return but they do react positively at times we

need it most (i.e. Oil Embargo, etc.).

Unlike most assets, there are no reasonable ways to

value gold. Gold has value because it always has and we

assume it always will. It does not generate profits or

interest, and is not used substantially as an input to pro-

duce anything that generates profits or interest. It is no

longer linked to any currencies. There obviously is value,

it is just impossible to value. Therefore, we cannot as-

certain or argue that it is overvalued or undervalued.


Although the definitions are murky at best, Venture

Capital typically focuses on start up funding, while Pri-

vate Equity typically focuses on later stage funding and

events (i.e. taking a company private, etc.). We do not

hold private funding for our investors primarily due to

the large amount of capital needed to invest in a diversi-

fied manner.

Real Estate

Although extremely localized and fragmented, we do

review nationwide commercial real estate assets as a

4

5

6

separate asset class. Interestingly, the dichotomy be-

tween the returns of REITS and privately held real estate

was astounding. There are several arguments that can

be made for REITS currently, the most compelling is that

they are able to raise capital easily, which is still difficult

for private real estate investors. However, we would

speculate that the dichotomy is mostly due to the gen-

eral liquidity of REITS and investors quickly crowding into

the space to pick up yield. This is not possible or advis-

able in private real estate.

Due to the massive inflows to REITS, REIT yields have compressed from over 5% at the beginning of the year

to just over 3%. We do continue to hold a position in REITS for the majority of our investors and, a large por-

tion of our investors hold private commercial real estate. We do have a concern that the investors can flee

the REIT space as quickly as they crowded into it and are considering trimming or adjusting our exposure.

Winter 2011 Newsletter - Business Owners

Documents

Transcript of Winter 2011 Newsletter - Business Owners