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Approximately Right

by Victor K. Lai


Year in review at BCM


With 2015 well underway, here’s a look back at the past year through the eyes of BCM -- it was a busy one! As you may know, we relocated our headquarters to San Ramon, CA. We continue to have an office in San Francisco for now, but all of our operations, books, and records are now based in San Ramon. Those who have visited both offices know that San Ramon has a different vibe than the bustling, concrete jungle of the San Francisco Financial District. Quiet, quaint, and lined with trees, our new space feels more like a national park than an office complex! It took some getting used to – but we’ve grown to love the calm feel and are planning for a long and comfortable stay.


Around the same time as our move, BCM also welcomed Wei Trieu as a partner. Wei came from Fidelity Investments where he was most recently a Vice President and Senior Account Executive. Wei enjoyed a successful, decade-long career at Fidelity, and his decision to leave wasn’t an easy one. Ultimately, Wei joined BCM because he believed the fully-independent, RIA-only model was the right (and best) way to serve his clients -- and of course his exceptional new colleagues didn’t hurt either. Whatever his reasons were, Wei’s proven to be an outstanding addition to BCM. We’re excited and fortunate to have him on the team!


Another welcome change over the past year was our adding of Charles Schwab Institutional for client custodial services. Not all our clients will custody their accounts at Charles Schwab, but many have chosen to do so. Charles Schwab is the undisputed leader in custodial services for RIA firms like BCM. In addition to top-notch back office and operational support, they have some of the most advanced technology for everything from account maintenance and portfolio management, to record keeping and reporting. We’re very pleased with the Schwab platform and are confident that they will be an important partner in supporting our continued growth.


Speaking of growth -- oh boy have we grown! Over the past year BCM grew assets under management from $24 million to $35 million. Over that period, we added no fewer than 15 new client relationships, and met with many more potential clients. Those who know us continue to recommend our services on a regular basis. Thank you for your support -- your referrals represent the ultimate vote of confidence, and that means the world to us! As always, we do our best to be a useful resource -- not only for our clients, but for their friends, family, and colleagues as well. So please feel free to reach out if you or anyone you know has financial questions or concerns – we’re here to help!


Market Commentary


In 2014, the global markets were a mixed bag. The US equity market registered another strong double digit year, and certain segments, like REITs, performed especially well. The S&P 500 and US NARIET Real Estate 50 indices were up 13.6% and 25.2%, respectively. However, the biggest story of the year wasn’t about strong returns, rather it was the dismal performance of crude oil prices, which fell by more than 50% in the second half of 2014!


Foreign stock markets were also challenged. Both foreign developed and emerging market equity markets were negative for the year. The EAFE and EMEA indices were negative 4.5% and 1.8%, respectively. Globally, the Russian equity market got the award for ugliest returns – the Russian market was down 45.9% for the year!


As the divergent returns show, there was no shortage of surprises in 2014. And if history is any precedent, we expect much of the same in the year ahead. Case in point, just as investors have been fleeing Russian stocks at a frantic pace, the Russian equity market has suddenly turned the corner to become one of the best performing markets in the world -- up over 16% year-to-date. Investors who sold out in heat of the panic have not only realized negative returns, but will likely miss out on the eventual rebound as well. Such is the problem with trying to precisely time the peaks and bottoms of fickle markets – more often than not it’s a losing proposition!


Time and Value


With respect to both timing and Russian stocks, I write from experience. I first took notice of the Russian equity market in 2013. Having already fallen 40% at the time, I thought it was a good time to consider Russian stocks. However, trying to time the bottom was like trying to “catch a falling knife.” The Russian market fell an additional 20% in the following year. By the end of 2014, it seemed like the free-fall would never end and waiting for a bottom seemed hopeless.


In January of this year I went out on a limb and said that it looked like the worst had finally been priced into Russian stocks. If my timing was right – it would have been lucky. My intention was not to time the bottom – I’d already given up on that!

What I just could not ignore, however, was the increasingly attractive valuation of the Russian stock market. Whether Russian equities had found a bottom or not, they were simply one of the lowest priced markets in the world. This was one of the key “BRIC” emerging markets trading at somewhere around 5x earnings. From that perspective, it really didn’t matter if the bottom had come or not – buying at such low valuations really tilted the odds in the buyer’s favor over time. Assuming Russia doesn’t fall off the face of the Earth (or some other similarly catastrophic event) it’s likely that Russia will get through its current problems and continue to be a key driver of future global growth. It’s just impossible to say when it will happen, but given a patient time horizon and a stomach for intermittent volatility, broad, long exposure to the Russian stock market looks like one of the most favorable opportunities in the world.

Approximately Right


It always surprises me how much investors emphasize precision. For example, so much attention is given to details like specific expected rates of return, earnings estimates to the penny, and GDP forecasts to the basis point. The emphasis on precision is ironic because markets are inherently fraught with uncertainty. When it comes to the markets, the reality is that the more precise the forecast, the more likely it will be incorrect. Ultimately, investors are rewarded simply for being right. And since it’s impossible to guarantee in advance whether a risk-bearing investment decision will be correct, the best investors can do is to be consistently more-likely-right than not!


In that sense, broad works better than precise. Saying that the S&P 500 will be higher in ten years is more likely to be correct than saying the S&P 500 will close at 4,832.78. Obvious, you say? Yes, of course! But that doesn’t change the reality that the first statement is more likely to be right – which is what really matters. It’s like what Warren Buffett once said “I’d rather be approximately right than precisely wrong.” Following lessons learned from the likes of the Oracle of Omaha, I’ve been watching several themes that I think will most likely be approximately right. No surprise -- these are broad, big-picture themes that don’t emphasis precision. I think of them as global, macro-level opportunities (but not to be confused with a “global macro strategy”). Russian stocks are one example, and I share several others below.


Final frontier


Among the “no-brainer” variety of long-term, buy and hold investments, I think broad exposure to the frontier markets is a good idea. These are the markets that are left after North America, the EAFE regions, and Emerging Markets have been accounted for. They are literally the final frontier of equity markets – basically regions including North Africa, the Middle East, and parts of South East Asia. As some of the least developed countries and financial markets in the world, there are obviously plenty of risks (heightened volatility, inflation, currency, geo-political, etc.). However, these markets should also arguably possess the most long-term upside potential given their early stages of development. Early, broad, market-wide exposure, by definition, ensures that an investor will end up owning all the future winners of the frontier markets. Of course it also means owning all the losers – but they disappear over time, and should be more than offset by the big upside. This is a position to be taken with a time horizon in the decades – with plenty of volatility along the way.


Paper Money


The Euro is down more than 34% against the US dollar since its high of around $1.60. At its low point, the Euro got to $1.03 -- nearly hitting parity against the dollar. There are plenty of potential reasons for the weakness. The Eurozone seems stuck in a slow growth environment and the ECB is still easing monetary policy. Juxtaposed against plans to tighten by the Fed and downward pressure on the Euro makes sense. At the same time, the ongoing “Grexit” drama is likely adding pressure as well. Speculation is rampant that failed negotiations with Greece could result in contagion and a failed Eurozone. Of course we’ve seen this story before (just a few years ago in fact). Like before, it’s still in everyone’s best interest to keep the Eurozone intact, and so that’s still most likely what will happen -- one way or another. If we accept that as the most likely outcome, and recognize that the Euro is trading near the lowest levels ever, bottom or not, the Euro just looks cheap right now. Currency markets are notoriously volatile and there’s no telling how long a rebound will take, but I think holding Euros at current prices and waiting for the drama to pass is more likely than not a good long-term bet.


Silver Lining


The price of silver is down more than 65% from its peak and back to where they were in the depths of the financial crisis. There could always be more downside, but at this point it’s hard to say that the metal doesn’t look oversold. Impending interest rate increases in the US present additional headwinds, rising rates are typically bad for commodities in general. And at the same time, there are no apparent catalysts for upside -- that is until there are! The market’s “risk-on / risk-off” switch can turn on a dime and without warning. Like gold, silver can be an effective hedge against stock market risk. So holding some of this semi-precious metal is not only a bet on long-term mean reversion, but it also doubles a way to balance against volatile equity exposure (like Russian stocks, for example).


Black Gold


By black gold, I mean oil of course. We all know what happened to oil prices last year – they got hammered, down more than 50% in a matter of months. The consensus explanation seems to be a combination of stagnant demand, increased US supplies, and reluctance from OPEC nations to reduce production. If it really is as simple as supply and demand imbalance, then it’s only a matter of time before the market sorts out the excess and prices adjust. Likewise, if this is just a classic case of prices rising too much too quickly, only to fall in the same manner, then it’s reasonable to expect mean reversion to prevail over time. The one scenario in which oil prices remain permanently depressed is if oil just becomes less valuable of a resource than it has been historically. Possible, but given the lack of realistic near-term substitutes, I don’t think that scenario is likely anytime soon. Accordingly, my money is on the more likely outcome that oil prices will rebound from their recent lows.


The Bottom Line


If the markets have taught me anything, it’s that investing and uncertainty go hand in hand. Even the best investors will attest that the most we can do is be “approximately right.” That doesn’t mean detailed research and due diligence don’t matter – because they do. It means no matter how detailed our analysis is, and how confident (or likely overconfident) we are about being right, we could be just plain wrong! Maintaining this humility reminds us of two things. First, that favorable odds matter more than precise forecasts, and second, that risk management is crucial to sustained success.


At BCM, our priority is adhering to a disciplined portfolio management process based on time-tested investing principles that emphasize exactly those things. Strategic asset allocation, proper diversification, broad market exposure, high cost efficiency, and maintaining a long-term perspective all help our clients keep the odds in their favor over time while also keeping risk within an acceptable range. While I provided some investment ideas in this letter, don’t let them overshadow the more important lessons. If you decide to take positions, remember not to invest more than you’re willing to lose, and be sure to incorporate them into a balanced and diversified portfolio appropriate for your needs and goals.


Along the way, if you have any questions, feel free to reach out to BCM -- thanks for reading!


Be Great,


Victor K. Lai


Bellwether Capital Management LLC (BCM) is a registered investment adviser (RIA). It provides investment management services for people and organizations. Please visit www.bellwethercm.com to learn more.


Disclosures


This is for informational purposes only. None of this information constitutes advice. None of this information constitutes an offer to buy or sell any financial product or service. Bellwether Capital Management LLC and its representatives do not provide tax, legal, or insurance advice; you should consult with the appropriate professional advisors for any matters related to those areas. Investors should understand that investing is inherently risky and it comes with the potential for principal loss. Performance cannot be guaranteed, there is no guarantee that an investor’s objectives will be met, and past results are no guarantee of future events. While this information is believed to be accurate, its accuracy cannot be guaranteed. The availability of investment products and services may differ based on jurisdiction. Everything herein is subject to Copyright by Bellwether Capital Management LLC. Unauthorized reproduction of this content in any part is strictly prohibited. You acknowledge that you have read, understand, and abide by these disclosures. In addition, you release Bellwether Capital Management LLC and any of its employees, representatives, affiliates, or other related parties from any liabilities related to using this information.

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