2017: More Growth and Some Caution
Firm Update When we started 7258, our vision was to take care of 50-60 like-minded families and manage $300 million by the end of 2020. I am happy to report we are ahead of schedule on achieving these ambitious goals. 2017 was another strong year – new families partnered with us, clients added money to their accounts, clients’ children opened accounts, and a client introduced their parents who subsequently engaged us. After completing our second calendar year, we are just shy of $150 million under our care, and our families have invested an average in excess of $7 million with 7258.
Our reach is well beyond Colorado. We are fortunate to work with families living in nine states who serve in a number of professions across a wide array of industries.
Our Clients Include:
Client portfolios are in capable hands. The 7258 Investment Committee is comprised of three CFA Charterholders with over fifty years of experience who, in addition to their 7258 responsibilities, advise on institutional portfolios valued in excess of $35 billion. The experience we gain by serving on other investment committees with astute professionals around the country is invaluable; our clients benefit from the many discussions we have on investment themes, managers, strategy, and asset allocation.
2017 Highlights 7258 Wealth Management became an S-Corporation in January. Shortly thereafter, our shareholders invested a great deal of time developing a mission statement and adopting principles to steer the important decisions we make every day.
We hosted former Wall Street Journal Columnist, Mr. Jonathan Clements. He addressed a packed room of clients, prospective clients, and professional advisors over lunch at the Ritz-Carlton. Jonathan shared his views on the impact overconfidence has on investors and how that affects their returns. Hosting this renowned personal finance expert was a milestone event for 7258; The Denver Post published this recap the next day: DenverPostClements.
Institutional Investor (II) invited me to address the RIA Institute again in Chicago. II asked me to share my perspectives on behavioral finance with the 70-80 Portfolio Managers attending their conference. It was an absolute honor to address this esteemed group so close to the University of Chicago where Richard Thaler was awarded a Nobel Prize in Economics for his behavioral finance research. Dr. Thaler sparked my interest in this fascinating area at Harvard in 2004. A summary of my remarks can be found at BehavioralFinanceBlog.
We invested significant time and money in improving our technology platform. Technology plays a key role in our ability to care for our growing number of families (which increased by over 54% in 2017). We implemented re-balancing software that allows our team to review every account on a daily basis to ensure the allocation to each investment is within the stipulated guardrails. The software also allows us to carefully manage the tax impact of each trade. Our tenacious focus on minimizing taxes and costs makes 7258 distinctive in an industry that can feel/sound commoditized.
Our team got stronger while our family got bigger. Steve Trainer, Portfolio Manager, earned the prestigious CFA (Chartered Financial Analyst) designation in September; this represents well over a thousand hours of study over three years and exemplifies Steve’s commitment to our profession and our clients. The fact that he took the CFA Level III exam immediately before the birth of his son speaks volumes about Steve… and his wonderful and forebearing wife, Yael. We welcomed Steve and Yael’s son, Finn, to the 7258 family on June 6th.
7258 in the Community
While we are fully committed to exceeding the expectations of our clients, we are also invested in our communities and do everything we can to make an impact beyond the walls of 7258. Here is a subset of the organizations our team is involved with:
- I am one of the Founders of the Mile High Five Foundation and currently serve as the President. We host one event each year with the proceeds benefitting youth-related causes in the Metro Denver Area. Our group has donated almost one million dollars to recipients since our formation.
- Steve Trainer serves on the board of Wilderness On Wheels (WOW), which provides access to nature for people with disabilities, their families, and caregivers. Nestled at the base of Kenosha Pass, WOW offers a one-mile long, eight-foot wide boardwalk that rises to 9,200 feet, a fishing pond, 13 campsites, 5 huts and 2 cabins—all wheelchair accessible.
- illiam Jennings, Director of Research, serves as the Chair of the Caring for Colorado Foundation Investment Committee. He is a gubernatorial appointee and his role facilitates the foundation’s goal of making $8 million in health care grants and programs each year.
- teve Fraser, Director of Analysis, is heavily involved with the Financial Planning Association of Southwest Florida. He serves as an Advisor to the Board of Directors, where he primarily looks to create and enhance professional development opportunities for students.
Tax experts and the financial press have published numerous high-quality summaries of the new legislation. We were paying very close attention to issues affecting investors as this legislation made its way through the halls of Congress. Our firm shares its name with the elevation of the United States Air Force Academy, and we care deeply about our great nation. However, 7258 eschews political debates and focuses our energy on those issues affecting investors. With that in mind, the reduction in corporate taxes will make American companies more competitive and lead to greater pricing power, higher margins, and stronger earnings growth – all of these are good outcomes for stock investors.
We were very concerned about a possible change in how investors determine their cost basis. Currently, when shareholders sell stock, they can choose which specific “lots” of shares to sell. Typically, it is good tax practice to sell the shares with the highest cost basis, which reduces the capital gain and the subsequent capital gains tax. (This is sometimes called HIFO, for Highest In, First Out.) The Senate’s tax bill included a provision which would have mandated investors use the cost basis of the first lots purchased when calculating capital gains/ losses; since the market typically goes up over time, this First In, First Out (FIFO) methodology would have largely resulted in investors paying higher taxes. 7258’s commitment to maximizing risk-adjusted, after-tax returns is one of the things that sets us apart. This provision would have hampered those efforts; thankfully, the FIFO provision did not make it into the final bill. We will continue to enhance our returns by actively harvest short-term losses in client portfolios.
In a year where emerging markets surged and investors piled into large cap growth stocks, the theme that stood out in 2017 is low volatility. As we enter the 10th anniversary of the financial crisis, it is prudent to remember that stock markets do go down. The S&P 500 has appreciated over 300% from the low in March 2009 and there have been only two material pullbacks since then: August 2011 (driven by troubles in Greece) and January 2016 (oil). Other than these brief periods, the stock market has been on an unprecedented steady climb. According to Standard and Poors, the S&P 500 set 62 closing highs in 2017 and added $3.55 trillion in appreciation and $420 billion in cash dividends. Consider the figures below as they provide three different perspectives to illustrate the market’s smooth ride:
As you can see, going back to 1995, there hasn’t ever been a year that delivered a positive return in the S&P 500 in every single month (the same holds true going back to 1950 but the boxes in the table got awfully small by going back that far). The S&P 500 has 14 consecutive months of gains – another first. The current equity market is unprecedented.
The evidence tells us emotions play a significant role in how people invest their own money; greed and fear can lead investors to do the wrong thing at the wrong time. Our concern is that a growing base of investors are becoming accustomed to this comfortable ride in the markets. By any measure, this period of low-tono volatility is exceptional, and we worry that market participants are becoming complacent; complacency could lead them to take more risk in their portfolios than they can stand. When (not if) the markets pull back, investors’ true risk tolerance will be revealed. If history is any indication, many will sell into declining markets and fear will feed on itself, which will drive the markets even lower. On the bright side, this manic selling will create opportunities for those investors that focus on the long-term.
At the end of 2007, Warren Buffett bet a hedge fund manager at Protégé Partners that the S&P 500 would outperform a basket of five Hedge Fund of Funds from 2008-17. This was not a friendly buy-you-lunch bet— the stakes were $1 million to be donated to charity. Buffett’s thesis was the fees in the Fund of Funds structure would be impossible to overcome and the S&P 500 would prevail. While Protégé won’t disclose the actual funds, the S&P 500 has outperformed Hedge Funds by almost 5% per year since 2008, and Protégé conceded the bet this May. We share Buffett’s aversion to fees and his cynicism regarding most hedge funds–especially as they relate to taxable investors. William Jennings summarized our thoughts on Hedge Funds in February: HedgeFundBlog. Buffett recently said he would make the same bet over the next ten years. So would we.
Since 7258 is a wealth management firm focused on delivering evidence-based strategies designed to help our clients achieve their objectives, Bitcoin and other cryptocurrencies have no place in our portfolios. While someone may decide to make a small gamble on one of these opaque vehicles (they are not investments), they would do well to keep the following figure in mind:
Should a “currency” have volatility like this? Would you expect widespread adoption of a medium of payment that fluctuates so much in price? As a merchant, would you accept something for goods/services that may be worth 5-10% less the same day? Bitcoin and other cryptocurrencies are not investments, they are not currencies, they are high-stake bets. Few can stomach the wagers’ volatility but some will try. This won’t end well for most. Caveat emptor.
We continue to use Dimensional Funds, Vanguard, The Aperio Group, Schwab, and Parametric for the management of our client portfolios. Our clients benefit from each managers’ lower-cost, more tax-efficient approach. 7258 portfolios are globally diversified and customized to the objectives of each of our clients. In terms of each asset class, here is our perspective as we enter 2018:
Equities — The evidence suggests that smaller, cheaper, and more profitable companies outperform over time, and we have maintained our exposure to these factors. The global stock market is comprised of approximately 53% US and 47% Non-US stocks. Our baseline equity portfolios are 65% US and 35% Non-US. This tilt to the US is primarily a function of our clients having dollar denominated expenses, which makes the “home bias” prudent. While smaller stocks and value stocks faced some headwinds in 2017, our equity exposure is designed for 5+ year time horizons. We don’t get distracted by quarterly or annual returns. Tax-smart management of stock portfolios will continue to add value over time.
Fixed Income — Interest rates have been in a downward trend over the last four decades, which has resulted in the greatest bull market bonds perhaps will ever see. While bonds have historically provided a source of income (and will again someday), we view them as providing a degree of protection in our client portfolios—we do not to take significant risk in bonds. As a result, we continue to favor higher quality, shorter-duration fixed income instruments. Our bond portfolios have an average credit quality of AA and two-thirds of the interest rate risk of the bond market. Our clients have exposure to Treasury Inflation Protected Securities (TIPS), which provide income with adjustments for inflation. As interest rates normalize in bonds, we will be able to reposition our shorter duration portfolios and earn higher yields (finally).
Real Estate — Rising interest rates will make REITs relatively less attractive, but we think the diversification the asset class provides necessitates the exposure in most client portfolios. We have added global REIT exposure for many of our clients which broadens the opportunity set and adds currency movement as an additional source of diversification. We are actively investigating further real asset investments.
We remain concerned about the markets as we enter 2018. The stock, bond, and real estate markets are relatively expensive by most metrics, and buying high hasn’t worked out well over time. Markets are pricing in a lot of really good news so an unexpected economic/exogenous event could certainly lead to a swift return to higher/normal levels of volatility. Economic growth is fairly sluggish despite the cost of capital (still) being very low and the economy being awfully close to full employment (virtually anyone who wants a job has one). Elevated growth in 2017 will provide stronger headwinds for earnings growth in 2018. While there is always conflict somewhere in the world, events and rhetoric in Europe and Asia introduce the slight possibility of a catastrophic confrontation that would devastate global equity markets. These are still exceedingly low-probability events, but the odds appear to be higher today than they were a year ago.
With that in mind, our clients have a lower allocation to stocks than they normally would. In many cases, their portfolio is equally split between stocks and bonds. This balanced approach is too conservative for many of our clients over the long-run, but this positioning will allow their portfolios to participate with further stock market gains but provide protection should the equity markets retreat.
We are humbled by the support of our clients, their families, and the many advisors who have introduced us to their clients. Our lower-cost, more tax-efficient approach is time-tested, and we continue to investigate ways we can be even better. These last two years have presented the challenge of a lifetime, but I wake up every day knowing the long hours are worth it. Putting clients first is the right way to build a firm. I want to close by thanking our families for putting up with the early mornings, late nights and never-ending text messages. Best wishes for a safe, healthy, and prosperous 2018.