Thoughts on Investing
As our Chief Portfolio Manager, Gary Martinelli is responsible for our overall philosophy and approach to investment management. He puts these into practices through the guiding principles, portfolio strategies and risk mitigation practices that we use to shape and manage each client’s investments.
Four Guiding Principles
Invest Selectively
We are “value” investors. As such, our goal is to attain superior long-term performance by acquiring securities of financially strong companies with understandable businesses run by capable management at market prices significantly below conservative estimates of their “intrinsic value.” In this pursuit, we conduct our own evaluations of individual securities and also invest in comparatively low cost, “no-load” mutual funds whose investment managers evaluate securities with value criteria similar to ours. For more information about “value investing,” read our Frequently Asked Questions
Evaluate and Manage Risk
We strive to consciously manage risk. Every investment opportunity carries associated risks. An early step in the investment process is identifying these risks to the extent possible. The next step is to take appropriate actions to reduce the impact of such risks through techniques including diversification, maintenance of levels of liquidity, and ownership of investment products affording a measure of protection in down markets. None of our risk management strategies can eliminate all portfolio volatility or insure against all losses.
Act on Information and Analysis
We are also “active” (rather than “passive” or “index”) investors. Based upon research and price awareness, we select the securities we think will perform best within the context of a client’s asset allocation. In contrast, a “passive” or “index” investor invests to match the proportion and performance of securities held in a specified index sum as a “large cap” index or an international index. For more information, read our Frequently Asked Questions
Allocate Assets Based on Each Client’s Circumstances and Sound Principles
Finally, we are “asset allocators.” For most clients, balancing one’s portfolio by allocating a portion to equity securities, an asset class that generally is more risky and potentially more rewarding than fixed-income securities (i.e., bonds), and allocating a portion to fixed-income or similar securities, is only common sense. Given the heightened volatility that has characterized securities market since 2007, pure preservation of capital has become a prime consideration. Each client, however, has his or her unique circumstances as well as an individual level of preparedness to assume risk. All of these considerations enter into our asset allocation recommendations.
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Portfolio Strategies
Martinelli Discenza considers all asset classes when designing client portfolios including common stocks, preferred stocks, bonds, REITs, royalty trusts, limited partnerships and, not unimportantly, cash. Each client portfolio, however, is managed as an individual “separate account” (rather than as part of a pool of assets) and each has its own mix of securities from various asset classes.
Notwithstanding the individualization of accounts, however, our experience has been that client risk and reward appetites fall into one of four broad categories:
Capital Appreciation Portfolios
For clients with a longer-term perspective, usually those who are building assets for retirement or whose immediate financial requirements are met from another source such as salary or rental income, we commonly invest with a view to Capital Appreciation.
Capital Appreciation portfolios are normally composed largely of equity securities, primarily common stock and no-load equity mutual funds. Depending on investment conditions and client risk tolerance, there will be a component with a greater or smaller cash reserve and an allocation to bonds or no-load bond mutual funds.
Income-Oriented Portfolios
For clients with an immediate or near-term need to derive current income from their portfolios, usually retirees or clients who for other reasons may not be in the work force, we invest with a view to income-generation.
Income-Oriented Portfolios are normally comprised of Government and corporate bonds and no-load bond mutual funds, preferred stocks, royalty trusts, limited partnerships, and some cash. Given today’s low yields on interest bearing bonds, there is an increasing allocation to dividend-bearing common stocks, particularly those with a long history of increasing dividend payouts. In general, Income-Oriented Portfolios are less volatile than Capital Appreciation Portfolios.
Balanced Portfolios
For clients who stand in the middle and desire both capital appreciation and income, we advise a Balanced Portfolio which combines elements of our Capital Appreciation and Income-Oriented Portfolios. The “balance” of the mix is not fixed. It is structured to met individual client requirements and is tactically adjusted depending on market conditions (i.e., when bond prices are high and yields low, we will be inclined to emphasize more equities and fewer bonds).
Bedrock Portfolios
For clients whose concerns about principal preservation and protection of the purchasing power of their financial assets outweigh their need for capital appreciation or income (usually clients with a high level of investment assets), Martinelli Discenza offers a Bedrock Portfolio. Focused neither on capital appreciation nor income, a Bedrock Portfolio is designed to minimize market volatility and to address concerns about deflation, inflation and the maintenance of “purchasing power.” Since inflation and deflation call for diametrically opposite strategies, Bedrock Portfolios are subject to ongoing, sometimes significant adjustments. Although the Bedrock Portfolio employs many of the same securities included in our other portfolios, it also emphasizes risk and volatility reduction through ownership of iinstruments (such as put options), which afford a measure of protection in down markets.
For clients who qualify as “accredited investors” under SEC regulations, Martinelli Discenza may recommend investments in “hedge funds” and other private partnerships which manage risk through the use of “derivative securities” such as options, and “hedging”. In general an “accredited investor” is a person with investment assets, excluding the value of his/her principal residence, with a market value of over $1,000,000 or with annual income for the most recent two years in excess of $200,000.
Since all clients share concerns about capital preservation and the purchasing power of the dollar, the thinking on which Bedrock Portfolios are premised influences our construction of all portfolios even though the emphasis is different and some components of a Bedrock Portfolio are not available to all clients.
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The Lessons of 2008 – Risk Management
The securities market debacle of 2008/early 2009 taught us a few important lessons:
First, we learned that despite the frequently invoked mantra of “diversification,” a mantra which we thought we had observed, in a liquidity crisis such as that which occurred in 2008 when heavily leveraged entities including banks, insurance companies, hedge funds, brokerage firms and individuals experienced “margin calls” and were forced to raise capital by selling securities, there was a high level of “correlation” among what had hitherto appeared to be distinct asset classes, i.e., stocks and corporate bonds, or stocks from different industry sectors. In other words, the bottom fell out of all markets (except for U.S. Government obligations and cash) at the same time.
Second, we learned that interim volatility matters. During the comparatively low volatility years at the end of the 20th Century, a “buy and hold” strategy may have worked well, But given the increased volatility in market prices during and after 2008, it is increasingly important to manage risk with a view to minimizing portfolio losses from which it may take years to recover.
As a consequence of these lessons, we are determined to focus more on managing the total risk of our portfolios while continuing to seek outstanding investment opportunities. Our focus on risk management may involve our committing of a higher proportion of assets to cash, to “risk-free” assets (i.e., US. Government securities), and to instruments (such as put options) designed to afford a measure of protection in down markets in client accounts. Since cash yields very little, interest rates on Government securities are low in today’s environment and a premium will be paid for downside protection products, our risk management initiatives will likely have the effect of reducing portfolio returns (but preserving capital).
We continue to evaluate other means of reducing portfolio risk.