Tag: premium


July 4, 2014

The founder and CEO of Kessler Investment Advisors is sticking to his guns and maintains that U.S. Treasury bonds will continue to be a major beneficiary.

Consuelo Mack: This week on WealthTrack, marching to the beat of a different drummer. While most of Wall Street has been preparing for rising interest rates and faster economic growth for years, Great Investor Robert Kessler has stuck to his low interest rate, slow growth theme… Kessler Investment Advisors’ Robert Kessler is next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. How many times in recent years have you heard money managers, financial advisors and economists say that interest rates are about to go up? And therefore advise you to shorten the maturities in your bond portfolios because long-term bonds, treasury bonds in particular are very sensitive to changes in interest rates. When interest rates go up, bond prices decline. When interest rates decline bond prices go up. That sensitivity has worked mostly to bond investors’ advantage over the last 30 plus years. Interest rates on 10-year U.S. Treasury notes, for instance have declined from a high of close to 16% in 1981 to a low of 1.4% in 2012. Treasury bonds have been great investments throughout. The yield has stayed near historic lows ever since.

What happens if rates start to go up? Here’s a chart from Altegris Advisors showing the impact on different types of bonds if interest rates rise one percent.

Prices of high yield corporate bonds would decline about 4%,.. Emerging market bonds would suffer about a 6% hit,… U.S. investment grade corporate bonds would experience a 7% fall ,… 7-10 year treasuries nearly 8%… And long term treasury bonds would plummet more than 16%- ouch!

Many pros have warned of that danger on this program for years now, including most recently Templeton Global Bond Fund’s Michael Hasenstab.

There has been one consistent hold out on WealthTrack over the years, who has stuck with his low interest rate theme and U.S. Treasuries. He is this week’s Great Investor guest. Robert Kessler is the founder and CEO of Kessler Investment Advisors, a manager of fixed income portfolios specializing in U.S. Treasuries, for institutions and high net worth individuals globally. For the 15 years that I have been interviewing him he has correctly predicted that interest rates would fall, then remain low and that U.S. treasuries would perform well. I began the interview by asking him why rates have stayed so subdued for so long.

ROBERT KESSLER: Let me say that I think when we talk about so long, you’re talking about a period of time from the beginning of the ‘80s until now, and so we consider that a very long period of time. The fact of the matter is we had very low interest rates from the early ‘30s until the ‘60s. So this is not an unusual situation, and also in global economies, free enterprise systems, capitalism, there’s always this pressing for lower and lower costs and lower and lower rates. It’s the nature of a good market system which we’re in.

CONSUELO MACK: And productivity and competition and all that stuff. Costs go down.

ROBERT KESSLER: Productivity. All the things that go with it, and there’s a good and bad for that. The good part is that prices come down, and over time generally, if you’re not having a war and you’re not having total fiscal irresponsibility … and in this country we have no fiscal policy, so we’re pretty good on that. So under these conditions there really is no reason to not expect rates to continue to kind of ratchet lower, and though last year I think when I was on this show, one of the prevalent kinds of conversations was this is the end of the bull market in Treasuries.


ROBERT KESSLER: And in bonds.

CONSUELO MACK: And in Treasuries especially, but bonds.

ROBERT KESSLER: And that’s kind of self-serving for an industry that really when you’re looking at a stock market up 30 percent last year or up six percent in the last month or so, the industry wants to see higher rates because that goes along with higher GDP, and higher GDP kind of gives you a market, an equity market that really can go higher. So if you look at Wall Street and you look at the financial community, the first thing everyone’s going to say is, “Well, things are really getting better,” and by the way, when they get better, rates have to go up. As long as I’ve been dealing with or you and I have been talking, in the Treasury market rates are always going up. I can’t think of a time in the last 30 years or so, whether it’s mortgage rates … mortgage rates in the late ‘80s for instance were around nine percent. If you asked anyone, “What do you think about financing your house this week?” “We better do it now, because rates are going up.” Rates are always going up.

CONSUELO MACK: Right. As far as the investment psyche is concerned.

ROBERT KESSLER: Sure. The real estate industry wants you to buy today because tomorrow the price will go higher.

CONSUELO MACK: So this some marketing ploy?

ROBERT KESSLER: Well, there are very sound reasons. We have, again, a marketplace of competitiveness. We have a marketplace right now in the Treasury market. We’ll talk about the Treasury market where actually the amount of Treasuries are shrinking. We had a deficit in this country of eight or nine hundred billion dollars, and now it’s going to drop to 600 billion. That means we’re going to issue less Treasuries.

CONSUELO MACK: Well, and the Federal Reserve, however, also owns or has been buying 50, 60, 70 percent of Treasury issuance, taking Treasuries off the market.

ROBERT KESSLER: It makes it even smaller in terms of the amount on the market, and the rest of the world looks at the United States. No matter how people may talk about it. We are the reserve currency. We are where you want to place money, and so as countries have grown and certainly countries have grown, regardless of whether they’re in a state of repression or kind of recessions, nonetheless there’s more money out there, and money has to go someplace, and so a huge amount of that comes into the safest, most secure security which is a Treasury. So there are really lots and lots of reason not even counting the fact, which is really important, that on a relative value Treasuries are very cheap right now, and the reason they say …

CONSUELO MACK: On a relative value to other markets that have sovereign debt.

ROBERT KESSLER: Sovereign debt. That’s right. We’re not even a high rate compared to a number of countries in Europe or Japan certainly. The 10-year rate in Japan as of today is around 60 basis points, 0.60. We are 2.60. The Bund which as a normal relationship, normal …

CONSUELO MACK: The German Bund.

ROBERT KESSLER: The German debt. Our normal relationship to the Bund is about 20 basis points over that yield.

CONSUELO MACK: So a fifth of a percentage point.

ROBERT KESSLER: A fifth of a percentage, and that yield happens to be around 1.4. So on a normal basis we would be around 1.6. Here we are at 2.6, and we’re also in a situation where risk assets, equity markets, real estate in London, excess housing in China, all of these places have inherently tremendous risk. The Treasury is interesting because though you perceive … well, what happens if rates go up? The fact of the matter is, no one says you have to do anything.

CONSUELO MACK: The natural order of things is for markets to revert to the mean, and when you’ve had a big rally in a market for almost 40 years then usually there’s a bottom at some point and the market will reverse which is what people are talking about with the Treasury bond market, that it’s rich, that it’s expensive, that it is due for a correction and that rates are due to come up especially with the economy recovery and the Federal Reserve withdrawing its easing program.

ROBERT KESSLER: Let me talk a little bit about the difference between a Treasury and interest rates, because we seem to group all of this together where people have said recently there’s a bubble in the credit market, and the implication is that Treasury yields are too low and, therefore, something has to happen, revert to the mean or whatever thing you want to say. The fact of the matter is there probably is a bubble in the credit market. That is, companies that we would consider risky, high yield, are at the narrowest relationship to Treasuries ever.

ROBERT KESSLER: Okay, that is probably very, very risky. It has nothing to do with the Treasury being there. The Treasury is there for one reason, because there’s no demand for money in the economy. We call that velocity, so all of this money that the Fed, that everyone likes to say, “Oh, they’re printing money,” it has gone into the banking system, and what has the banking system done? Nothing. They don’t lend it. It sits there, and so in an economy that has the kind of employment problems we have, and we have very serious employment problems where student loans have averaged now … 40 million people with student loans have $30,000 or more. In 2007, people needing food assistance … that’s a polite way of saying food stamps … we had 26 million. Now we have 47 million. All of these are known as consumers, and if you don’t have this kind of consumption coming into the market, where is the demand going to come from?

CONSUELO MACK: So Robert, when I talked to you before this and we sat down for this TV interview, you actually said that you thought that things were significantly worse than they were a year ago, and they are dramatically different this year than when we talked a year ago. Now by most measures, other people would look at the economy, for instance, and how business is doing, and they would say actually we’ve had some gradual improvement. We have an energy revolution, an energy renaissance going on. We have a manufacturing renaissance. That in fact the U.S. economy is in relatively good shape, and it’s stable. It’s not great growth but it’s okay growth. So what’s dramatically changed in your mind from a year ago that the rest of us are missing?

ROBERT KESSLER: It’s worse for this reason.

CONSUELO MACK: And what’s worse?

ROBERT KESSLER: It’s worse for this reason. We have never in this world that we live in seen a central bank for 28 countries reduce the rate down to a minus number.

CONSUELO MACK: As they have in the ECB.

ROBERT KESSLER: As they have in the ECB, and that’s Europe.

CONSUELO MACK: Right, in Europe.

ROBERT KESSLER: Europe is sitting with 12 percent unemployment. It’s not even changing, and that’s not counting Greece or Spain or countries in the peripheral area that aren’t improving. If you look at China, every week that goes by there are three or four articles in every single newspaper about the bubble in housing, in excess capacity. Excess capacity is interesting in China. We in the United States have a capacity utilization of around 79 percent, not too bad.

CONSUELO MACK: So we’re using the factories, and the production capacity is at 79 percent of what they could produce.

ROBERT KESSLER: China, 60 percent, an incredible figure. It means there’s so much excess in China, that whether it’s housing, whether it’s employment, whether it’s factory. So you have that on one side, China, Europe on this side. Actually the central bank telling you it’s so serious. When I was sitting with you last time, we were going through the crisis in Europe. Now they’re actually recognizing the crisis in Europe. Then we have the United States which now says more or less Wall Street, the financial community, “excuse me we’re decoupled”. Decoupled means that this country can get along perfectly well without anyone, and we know that that’s simply untrue.

CONSUELO MACK: It’s just not true.

ROBERT KESSLER: So when you ask me, is it better? Sure, it’s better for segments of the U.S. population. It’s not better for the housing industry which looks like it’s turning down, not up any longer, and if you look at employment in housing, we’ve lost a million six hundred thousand jobs over the last five years, and we’re not getting them back. Those are good-paying jobs. Where have they gone? We’ve actually brought it into health care and areas which are lower-paying jobs. So is it really getting better? Silicon Valley certainly is getting better, and certainly the stock market is up, but that belies the point that a vast majority of Americans are not getting higher wages. They’re getting lower wages. The CPI that came out, an interesting number, because everyone went a little bit bonkers over a higher CPI. The Federal Reserve said, “Well, it’s a little noise.” I would suggest that PCE, which is what the Federal Reserve watches, another inflation gauge, is at 1.5 percent. It really hasn’t moved.
I think people are taking a greater … I’m not suggesting people shouldn’t own stocks. I’ve never done that, equities, but they’re taking a greater and greater risk in a marketplace after four or five years where everyone acknowledges this is the weakest recovery in history. But don’t worry; things are getting better. And I would suggest my job isn’t to come on and sell something. I mean, in the Treasury business we can be long or short from our fund, and that’s a trading mechanism.

CONSUELO MACK: Right, and so talk about that because you have been, even though you are a long-term Treasury bull at Kessler Investment Advisors, you certainly have shorted depending on what’s going on in the market. You’ve certainly shorted Treasuries on and off.

ROBERT KESSLER: And I don’t recommend anyone do what we do. I mean, we do it on a professional basis. The purpose of a Treasury shouldn’t be misunderstood to be a trading mechanism, a trading vehicle. The purpose of a Treasury is to know that money will be there and that you’ll get a certain return from it. Believe me. There’s nothing wrong with 2.60, 2.6 percent when money market in Europe is paying minus 0.10 or in the United States paying zero.

CONSUELO MACK: But it certainly is if you’re thinking out 10 years because, again, historically … and correct me if I’m wrong … normally we do have inflationary periods and interest rates do go up and down. So if you’re dealing with your purchasing power, 2.6 percent a year over 10 years seems like a very low rate of return compared to what we’ve had in recent history at any rate, at least in the last three years.

ROBERT KESSLER: And you’re suggesting that over the next 10 years something very positive is going to happen, meaning that prices are going up. Wages will start going up, because …

CONSUELO MACK: That’s the optimist in me.

ROBERT KESSLER: Without wages going up, believe me there’s no consumption. I would suggest to you that this deleveraging process, the mess we got into in 2007, ’08, the consumer, the household that got into this high amount of debt is in the middle of the process of bringing it back down so that there can be consumption. You can’t have …

CONSUELO MACK: So six years in, we’re kind of midway.

ROBERT KESSLER: I mean, it could be four more years. It could be seven more years. I don’t have a clue, but I do know one thing. The risk during that period of time is enormous, and when you step into a market like the equity market, one of the things that you hear, it’s cute. It’s a Wall Street thing. Listen. You know, had you not bought equities over the last four or five years, you missed out on one of the great rallies in the world. Thank you very much, but you forgot to tell me about had I been there in 2002 and ’03 and lost half my money in 2007 and ’08. You just kind of conveniently forgot that part.

CONSUELO MACK: Right. As if we all came in at the bottom.

ROBERT KESSLER: Yeah, we all came in at the bottom which we never do. I certainly don’t. I’m not that smart, and we probably don’t do that. So the risk isn’t that you put all your money. I mean, I’ve heard recently, and we all hear it, now I put even more money in equities. What do you think of that? And the answer to that is when you start hearing that talk, don’t do it. It’s reasonable to be careful, and I’m only suggesting that the Treasury market, and I’m not even suggesting the general credit market any longer.

CONSUELO MACK: So you’re not suggesting the general credit market, so when you compared Treasuries, for instance, to high-yield bonds, so looking at other debt instruments.

ROBERT KESSLER: For a point and a half percent more or half a percent, why are you doing this?

CONSUELO MACK: You mean taking that kind of risk.

ROBERT KESSLER: Taking that extra risk for that, and the risk is enormous because we know for sure that the Treasury will pay off. We know that the worst that can happen if you have a 10-year Treasury is you have to stick around for 10 years. It’s possible that if Robert Kessler is right, rates actually go down substantially from here.

CONSUELO MACK: And that is basically your prediction, is that you think that rates will go down substantially from here. Of course, from two and a half percent, substantially can be half a percentage point or something.

ROBERT KESSLER: I don’t see any logical reason that your European rates, that we’re competing with the Spanish and the Greek and the Italian rates, and they’re right virtually even with the U.S. rates.

CONSUELO MACK: So who’s credit would you rather … ?

ROBERT KESSLER: Who’s credit would you rather have, and why should we be so different than the German rate? We are the reserve currency. So if you say, “Well, I don’t know. I think things will settle down,” you talk about reverting to the mean, reverting which mean? There’s no particular reason why you can’t see rates at one and a half percent considering that rates are zero. You get zero for rates right here. As to whether the Fed is going to raise rates which, of course, Wall Street would always like you to believe … oh, the Fed is always going to raise rates. There’s never a time other than when the market crashes that Wall Street agrees rates are coming down. Other than that, rates are always going up. So my guess is the Fed is correct. They’re not terribly correct on prognosticating where the GDP is, and there’s a reason for that. They are the head banker. What are they going to tell you? Things are not good? They always tell you things are going to be better and, in fact, it tends to be in the last three or four years wrong.

So probably we’ll kind of muddle along. Hopefully we’ll keep doing one to two percent, and that’s probably what we’ll do. Rates will stay at zero, and how long will that be? If we don’t get into trouble, if China doesn’t kind of have a hard landing which is plausible, if Europe doesn’t get into more of a mess than they’re in already, if the United States doesn’t turn down because housing certainly doesn’t look like it’s going up any more. So in this fragile global world we live in, we are not decoupled. We are part of this whole thing, and I would just suggest that the Treasury market is very attractive.

CONSUELO MACK: Rates of return that you get in the stock market, however, over time, and if you’re talking about reinvesting dividends for instance, and there are many companies that have dividend streams that are growing, and if you reinvest them, they basically keep up with inflation. They actually …

ROBERT KESSLER: So let me debunk this. This gets a little …

CONSUELO MACK: So that’s the argument as to why should I settle for 2.6 percent when I can get growing dividends and reinvest them.

ROBERT KESSLER: If you take 2000 to today, so if we just kind of ran numbers, if you had let’s take a zero coupon Treasury, a long-term Treasury, you’d be making an annualized return of around 15 percent. That’s 14 years annualized return.

CONSUELO MACK: Right, which is incredible.

ROBERT KESSLER: Great, well, all right. So the stock market, the equity market, had you done the same thing, three and a half percent dividends reinvested. Not impressive. Okay, for the last four or five years which is the years that we all want to really get crazy about, the equity market would have brought you 22 percent annualized. Fantastic. And that same bond market, if you only took that period of time which is not great, you made around 10.

CONSUELO MACK: Annualized.

ROBERT KESSLER: Ten annualized. So I give you 15 and 10, and it’s not an equity. An equity has what’s known as a down side to it. Is this unlimited period of time on a call. It’s not 10 years. It’s not five years. It’s not 30. It’s unlimited.

CONSUELO MACK: Right. If you hold a bond to maturity, however, you know you’re going to get, and so that’s your point is to hold it to maturity.

ROBERT KESSLER: Well, or not, and we’re talking about just rolling Treasuries over this period of time. If I take it from 1980, it’s going to look the same way. There’s a mystique, a seductive kind of a question with equities, and we all love it. I mean, there’s nothing that’s better than buying an equity when it goes up. It’s when it goes down, and I’m not knocking equities. Believe me.

CONSUELO MACK: One investment for a long-term diversified portfolio. What would you have us all own some of?

ROBERT KESSLER: Buy a long-term zero coupon bond. I mean it more than I meant last year. It wasn’t so terrible this year. Rates right now on the long-term market are roughly three and a half percent. If it goes down to three which I would expect frankly by the end of the year … that’s a good call. I think the end of the year … that would be about an 11, 12 percent return. That’s not a big deal because long-term Treasuries were at two and a half percent going back a year or so ago. If it doesn’t go down, part of your portfolio will be getting three and a half percent, and if you’re a long-term player which everyone says about the equity market … thank you, we’re buying it for the … although when everyone tells you we’re buying it for the long term, it means they’re not making any money, but they’re buying it for the long term. Then you need to buy Treasuries and think of it as a part of your portfolio. I’m not suggesting it’s your whole portfolio. It’s part of your portfolio, and the reason I think you don’t hear that enough is because if you suggest that, you’re also suggesting rates will stay low, and rates staying low means GDP stays low. It means equities are not earning as much money as we’re being told, and so you never sell Treasuries.

CONSUELO MACK: Robert Kessler.

CONSUELO MACK: Always a treat to have you, and we will have you back at the same time next year to see if you are right again 10 years later.

ROBERT KESSLER: Thank you very, very much, and it’s my pleasure being here. Thank you.

CONSUELO MACK: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is ignore the crowd and own some U.S. Treasury bills, notes or bonds for their liquidity and security. . .

There are multiple geopolitical hot spots in the world right now, shaking investor confidence. There are economic challenges in many parts of the globe as well and the U.S. stock market is trading at or near record levels. U.S. treasuries are the investment of choice in times of uncertainty and trouble. Having some treasuries in your portfolio can provide insurance and stability.

I hope you can join us next week. We are going to sit down with another contrarian, this time in the stock world. Veteran investor Steve Leuthold explains why he is investing in nuclear energy and China in his new firm, Leuthold Strategies.

In the meantime to see more of our interview with Robert Kessler check out extra on our website. We will also discuss the role of prenups in the WealthTrack Women section of our website. Have a great Fourth of July weekend and make the week ahead a profitable and a productive one.


June 27, 2014

Consuelo Mack: On this week’s Consuelo Mack WealthTrack building financial security for women…two award winning financial advisors Maura Griffin and Debra Taylor give us the essential building blocks to construct a plan to last a lifetime next on Consuelo Mack WealthTrack.

Hello and welcome to this special WealthTrack Women edition, I’m Consuelo Mack. Since we launched WealthTrack in 2005 our goal has been to help our viewers build long-term financial security through disciplined diversified investing with advice from some of the top professionals in the business.

This week is no exception. We are interviewing two award winning financial advisors who are devoted to helping their clients achieve financial security, with particular emphasis on their women clients. They are part of our WealthTrack Women feature on our website wealthtrack.com.

For the most part we have been gender neutral on WealthTrack, figuring sound advice applies to everyone. But on the topic of financial planning there are some distinct differences and facts pertaining specifically to women that we cannot ignore.

Individual circumstances can vary but these generalizations apply to most:
–Women live several years longer than men do. That means they have more longevity risk. –Women are far more likely to be alone as they get older. –Only 18% of women over 85 are married whereas 58% of men are. –Women’s spend nearly 3x more than men do on long-term care. –Yet women’s retirement income is substantially less than men’s. Some $21,000 on average for women over 65 versus $37,000 for men.

Yet there is what is called a “perilous paradox” for women. Despite their financial needs many don’t adequately plan for their financial future. They are too busy taking care of everyone else. And that is where this week’s guests come in. They are here to help women build financial plans.

Maura Griffin is the founder and CEO of Blue Spark Capital Advisors, a New York City based, fee only firm providing investment advice, asset management and financial planning for women, men and their families. A certified financial planner, she was given the 2013 Women’s Choice Award for Financial Advisors.

Debra Taylor is the principal of Taylor Financial Group, a full service wealth management firm based in Franklin Lakes, New Jersey. She started her career as a lawyer and is a licensed certified public accountant and financial planner as well as being a certified divorce financial analyst. She is also the recipient of the 2013 Women’s Choice Award for Financial Advisors.

I began the interview by asking them what is the first thing they want to know when a woman client walks into their office for the first time.

MAURA GRIFFIN: When a woman walks in my office, what I want to know is her story. I want to know why she’s here. I want to know what brought her to my office. I want to know about her family. I want to know about her kids and her parents. Is she sandwiched? Is she taking care of people? Often what brings people into my office is some kind of a life change, either a single woman who’s gotten an inheritance or a woman who’s divorced and is suddenly taking care of the finances by herself; and the same with widows. So I want to know all of that because all of that detail matters, the big picture. Then we can dig into the details.

CONSUELO MACK: Debbie, what’s the first thing you want to know about a woman client when she walks in the door?

DEBRA TAYLOR: The first thing I ask is, “Why are you here?” So I want to find out why they’re here, what triggered them coming to my office, and then the same thing that Maura says is, I want to know what your story is. What’s going on in your life that has made you decide to make the big move of coming to see a financial advisor? Because for many women, that is a big move. The other question I like to ask right up front is, what does money mean to you? Because you’re going to get, I think, generally different answers from a woman than you might from a man. And the other thing is, what are your goals? What are your dreams? What are you hoping to accomplish?

CONSUELO MACK: Getting a story from a woman client, is that approach different than it would be for a man, for instance? Do you want to know the whole picture when a guy comes into your office.

MAURA GRIFFIN: It’s a bit of a different conversation when a man or a couple comes in. I want to know all the same details, but the questions that a man asks, a man wants to know about the likelihood of market out performance. A man wants to know about sharp ratios. A man wants to know about benchmarks. But a woman wants to talk about her goals and whether her assets can help her get there, and it’s a much softer conversation. It’s a much more emotional conversation.

CONSUELO MACK: Is that the case for you as well, Debbie? DEBRA TAYLOR: My experience is exactly the same. I’m trying to have the woman open up and feel comfortable, so you do need to create a little bit of a softer environment where she feels comfortable having these discussions and exploring topics that she may never have felt comfortable exploring before. With the men, typically you need to be more data driven. They’re not so interested in their story being shared with you or that you’ve played the role of financial therapist to them. They want to know about fees, and data, and alpha, and beta, and stocks, generally.

CONSUELO MACK: Both of you deal with men and women and families. Also, one of the reasons you’re here is you’ve won awards for actually helping women, specifically. So the conversation then is different. What are the questions you wish women would ask more often?

MAURA GRIFFIN: I wish they would ask more questions in general. One big question that I don’t get asked a lot, but I think should be a question is, what is your value? What do you as a financial advisor bring to the table? It’s obviously smart wealth management but it’s also having a second opinion, to have a trusted confidante, a fiduciary confidante who can help you through all of the decisions that you will be facing really for the rest of your life.

CONSUELO MACK: So what’s the question that you wish that women would ask you that they don’t necessarily?

DEBRA TAYLOR: The question that should be on everyone’s mind is, how do I achieve financial security? That’s really the goal at the end of the day.

CONSUELO MACK: Do men ask that question?

DEBRA TAYLOR: Generally not.

CONSUELO MACK: Generally not. So the financial security, because isn’t that what … I mean, we’ve looked at a lot of surveys, and you know all of the stats as well. Financial security is huge for a woman.

MAURA GRIFFIN: Well, it’s supposed to be huge for everybody. That’s the end game.

CONSUELO MACK: How prevalent is the bag lady syndrome for instance?

MAURA GRIFFIN: Absolutely, to a one, every woman client I have, whether it’s $10 million or whether it’s half a million, they are all afraid, and they all mention the bag lady.

CONSUELO MACK: And why is that? Why are we so insecure about where we’re going to end up?

MAURA GRIFFIN: It’s an interesting question because I will say I have never talked to a man who says, “I’m afraid of being homeless.” No matter what their financial … it can be very precarious, but they never worry. They never express the fear of being homeless, or the bag lady syndrome.

CONSUELO MACK: Explain this, Debbie. Why is this an issue for women and it’s not for men?

DEBRA TAYLOR: I think culturally from the time women are little girls there are messages sent out that women or girls are not good at math. We’re not supposed to be capable in that area, finance, math, numbers; and that message is sent from society from a very young age. We see the statistics where the girls will start off very strong in math and by middle school they start dropping out of the more advanced math classes, and by the time then they get to be middle-aged, particularly if they choose to work within the home, they’re becoming, in certain respects, disenfranchised from the family finances and from that empowerment that they need. So particularly then if there is a divorce or death where then overnight they are thrust into this leadership role in handling finances, it is overwhelming, and they’ve had literally no experience in dealing with this and with lack of experience and lack of education comes fear.

CONSUELO MACK: We’ve talked a lot on WealthTrack about longevity risk which is something that you talk about and you’re very aware of with your clients as well. Longevity risk, how does that conversation happen with your clients?

MAURA GRIFFIN: It’s a question that we always bring up, and, to know that when we’re projecting out for inflation, for health care costs, for investment returns, we look at sometimes a 10 or 15-year period more than men.

CONSUELO MACK: Ten or 15 years more than men, just to be on the safe side? Is that why?

MAURA GRIFFIN: Just to be on the safe side. So the longevity risk I think is something that, even more than market volatility or some of the other issues for women, it.

CONSUELO MACK: How does that conversation happen with your women clients?

DEBRA TAYLOR: It happens in a very serious way. I had one client who is recently divorced, and she’s in her late 40s, and she has $4 million, and I basically sat her down and created an entire road map, saying, “I need to plan for you to live until age 95, and at the rate you’re going you will run out of money.” She got absolutely panicked, because I’m probably one of the first people in her life at least recently to tell her no to something, and she literally turned to me and she said, “Debbie, you’re scaring me.” And I said, “I am trying to scare you.” So we sat down, and I basically showed her how her $4 million, which seems like a lot of money now but with the way she was spending it, she would be running out of that money, and then she was listening very receptive and we created a very comfortable road map for her.

CONSUELO MACK: Women go through a whole bunch of transitions during life. We play a lot of different roles. How important is what role we are playing now, and what role we might play later in life? If we’re married, for instance, we’re probably going to end up being widowed. If we have parents, we’re going to probably end up being the caretaker for our parents at some point. How important are those roles in this kind of a conversation?

MAURA GRIFFIN: Very important in this conversation. You know, the statistics say that men, 80 percent of men will die married and 80 percent of women will die alone.


MAURA GRIFFIN: So whether it’s a couple or if it’s a woman, a single woman never married, divorced, widowed, all of these stages need a road map.

CONSUELO MACK: How do you plan for that with your women clients, Debbie?

DEBRA TAYLOR: So part of the planning is creating that financial plan or that road map. It’s absolutely critical, and then it drives a lot of the other decisions such as the types of investments you have because women typically will have more conservative investments than men. Even if they’re in their 60s or 70s, they’ll say, “Well, I’m in my 60s or 70s. I should be conservative,” and I’ll say, “You’ve got another 35 years. And I don’t want you showing up here in 35 years without money. You cannot be at my doorstep,” and they say, “Well, Debbie, I don’t want to be at your doorstep either.” I say, “Well, then we need to deal with that now.” So part of it then is, the road map is critical. Coming back and revisiting the road map at least annually to make sure that we’re on course; and then a big thing also is long-term care insurance and dealing with the health insurance aspect, because that’s becoming more and more of a big uncertainty and a variable with all the changes. So one of the things we typically recommend is long-term care insurance but also budgeting for that as well, because we see that the woman is going to take care of the man. Who is going to be there to take care of her?

CONSUELO MACK: The long-term care insurance then is more important generally for a woman to have than it is for a man to have? Is that fair to say?

DEBRA TAYLOR: I think it’s fair to say. I do. I would like to recommend it to both, but there are times where the men are not interested in it, and I understand because I will sit there and say to the man, “I know you’re not interested in it because you know that she’s going to take care of you, but what’s going to happen to her when you’re gone?”

CONSUELO MACK: Another issue is for single mothers and that again, that’s a more prevalent trend now as well. Is it suddenly as a single mother there are other concerns that you have that you’re not if you are a married mother? So what are those concerns?

MAURA GRIFFIN: I think some of the most important concerns for single mothers would be to make sure that your estate plan is in order. You want to make sure that if anything happens to you that, especially with minor children, that they are going to be taken care of. You need to establish guardianship. You need to make sure that you have enough life insurance that they will be able to thrive.

CONSUELO MACK: Debbie, I know that you deal with divorced women and you deal with widows as well, and there’s this old maxim that you shouldn’t do anything different the first year once you’re widowed, for instance, or divorced. Don’t do anything different. Don’t sell the house. Don’t change jobs, whatever. What’s the first thing that we should do if we have a major lifestyle change like that?

DEBRA TAYLOR: So for a widow, I would say there’s basically three stages, and there’s articles and books on this. So the first stage is like you’re saying, is let’s not make any major decisions right now, and let’s just try to take care of ourselves. So there’s a grieving process, and it’s just sort of coming to terms with our new life. So early on we basically just try to stabilize the situation. Let’s probate the estate. Let’s make sure tax issues are dealt with, just stabilization.

The second phase is then trying to put in the plan for our new life basically, coming to grips with what our new life looks like, what we need to do. And then really ideally, and this is, to me, the most exciting phase is that third phase, which is to me that empowerment phase where you’ve come to grips with your new life. You are actually excited about some of the possibilities that you have, and then we start getting creative with helping families, helping community. The widow exploring hobbies that she never could explore before because maybe she was taking care of a sick husband or taking care of her family; and that phase is really exciting to me as a financial advisor, and I feel like that’s where we get our best work done. So it’s really very fulfilling work.

CONSUELO MACK: What are the biggest pitfalls that widows, new widows, face?

DEBRA TAYLOR: they really struggle with how to manage expectations with their adult children. They want to help them, but sometimes they need to say no, and that’s a real struggle for them.

CONSUELO MACK: Is that a role that you have to play?

DEBRA TAYLOR: It is. I will sit with them. I will create the plan with them. I will make recommendations as to what they should and should not be doing, and at times I say, “Have Suzy call me directly, and I will explain to Suzy why you’re not going to loan her $400,000 for a beach house.”

CONSUELO MACK: Suzy, the daughter.

DEBRA TAYLOR: Yes, who is the adult daughter by the way.

CONSUELO MACK: So you were nodding, Maura. Is that a familiar theme for you as well?

MAURA GRIFFIN: It is. You know, becoming a widow happens sometimes overnight, but the process of widowhood and growing through that is a multi-year phase. Like the first year right after it happens, this first stage is … actually the grief sometimes is so overpowering that- it changes your brain chemistry. Your brain goes into sort of like the reptilian mode, and…

CONSUELO MACK: So where you’re paralyzed.

MAURA GRIFFIN: So you’re paralyzed. Very hard to make financial decisions because basically your higher cognitive functioning isn’t working the way it usually does, and some of these women are having to make financial decisions for the first time. I have one client who her husband died, and she wanted to change everything immediately. She was in so much grief. She wanted to sell the house. She wanted to move across the country to be with her children, and we needed to really talk about what the outcomes would be for all of those.

CONSUELO MACK: Another huge transition obviously is a divorce. What are the first steps that divorcees should take, and I should also ask both of you what the biggest mistakes are that newly divorced people make.

DEBRA TAYLOR: So in my experience dealing with newly divorced women or women who are about to get divorced is we need to build the team, and what happens is the man generally has been working outside the home, and he has an attorney. He has a CPA. He has all these people lined up. The woman, generally speaking, doesn’t have the team in place, so she’s several steps behind the man. Also she’s more emotionally connected. So what I find is once the divorce becomes an imminent possibility, it becomes a business transaction for the man. They basically compartmentalize, flip the tape, and they’re like, “Okay, Joe, you’re the attorney. Let’s deal with this. I got my CPA over here. Let’s get to work.” The woman struggles with months and maybe even years of creating the team. I’m not saying it has to become a business transaction, but an understanding that this is her new reality and she needs to protect herself, and the men generally are pretty good at protecting themselves. The women struggle with that.CONSUELO MACK: Women need that kind of protection and that kind of team behind them as well in order to even just have parity in their divorce proceeding. Right?

DEBRA TAYLOR: Right. So I had one client, and the man was saying, “Well, let’s go to mediation, but you don’t need to bring an attorney. Let’s just go the two of us.” Well, he’s very sophisticated. He does the investments. He has the tax returns. She has no clue. She has no clue what their net worth is, where their money is. How can you say let’s go to mediation and not bring attorneys when she has no idea? And I told her, “Don’t you dare go. Do not go without an attorney. And if you do go with an attorney, you should also consider bringing somebody like me, but at the very least do not go without an attorney.”

CONSUELO MACK: So Maura, what are the biggest pitfalls that women face, newly divorced women or about to be divorced women?

MAURA GRIFFIN: I think one of the biggest pitfalls that divorcing or newly divorced women make is not properly budgeting, that they don’t realize how expensive life is outside of the combined economic unit of the family, that there are two of everything, two households, childcare costs. Even babysitting costs go way up because you can’t go out. You used to leave the kids with the husband when you went out, and now you’ve got to pay for care. Everything has to be taken into account.

DEBRA TAYLOR: The challenge with divorce is what I find is men might take a step or two back, but then within years they’re back on course because they’re working outside the home. They have lucrative careers. Often the women get the children. There’s some nominal child support that’s provided to them, but at the end of the day all those additional expenses that are connected with raising children and running that household, they’re falling primarily on her, and let’s face it. It’s almost impossible to anticipate what all those expenses are in today’s world.

CONSUELO MACK: What about a woman who’s going to get remarried? That’s a whole other set of challenges, and obviously now prenups. Everyone says you’re nuts if you don’t have a prenup. Is that correct as far as your women clients are concerned?

MAURA GRIFFIN: And this is a question that comes up often. So a woman particularly who’s been divorced before and she’s thinking about getting remarried, and some of my clients make significantly more than their potential husbands.

CONSUELO MACK: So that can happen in a second marriage. That’s a danger for women who are doing well financially.

MAURA GRIFFIN: It is, and so it’s part of my job to make sure we think about all the risks and how to plan for those risks.

CONSUELO MACK: Debbie, a woman about to be remarried … absolutely a necessity to have a prenup?

DEBRA TAYLOR: I believe so. Now whether they get it or not is a different thing because it becomes very contentious, but I’d like to think that we’ve learned from lessons from the first go- around, and the second marriages can be very, very tricky. I have a number of couples that are on their second marriages, and often they have children from previous marriages so that there’s a lot of conflict as far as money, spending, inheritances, who the beneficiaries of the IRAs are. There’s a tremendous amount of conflict, and so on the second marriages I am very much a financial therapist because there is so much tension and conflict there. So what I would say that at the very least early on we need to have thoughtful conversations and literally maybe have a therapist or a minister involved, or somebody to help work through some of these issues. For better or worse a prenuptial agreement often helps you to hammer out those issues in advance, however uncomfortable that may be.

CONSUELO MACK: We always ask all of our guests what is the one investment for a long-term diversified portfolio or the one thing that we should do. What would your suggestion be, Maura?

MAURA GRIFFIN: So I think women need to be less cautious in their investments. A strategy is to have the first three to five years of their needs in completely safe investments and then take a look at being riskier, going into more equities because they’re going to live a long time. Even if they have perhaps a more risk-averse personality, that doesn’t mean they have to put that on their whole portfolio. They’re going to need to grow that money but still be able to sleep at night knowing that the market fluctuations are not going impact the money that they need to live in the next several years.

CONSUELO MACK: That’s good advice. Debbie, what’s your one investment or one thing that we should all do?

DEBRA TAYLOR: So to piggyback on Maura’s recommendations regarding the bucket approach is what I would say is, let’s do an overlay of a financial plan with that. So let’s have our bucket approach, and let’s understand then the type of spending we need to be doing and how long our assets are designed to support us, and our other causes or things that are important to us.

CONSUELO MACK: And a bucket approach, you’re talking about have cash or liquid investments to support you for two or three years and then another bucket is the more longer term, more risky but growth assets.

DEBRA TAYLOR: That’s right. That’s right,

CONSUELO MACK: So Maura Griffin, so great to have you and Debbie Taylor as well. Thank you both very much. Thank you for advising us and for advising your clients.

DEBRA TAYLOR: Thank you for having us.

CONSUELO MACK: They’re very lucky indeed.

MAURA GRIFFIN: My pleasure.


As we mentioned earlier, Griffin and Taylor are part of our WealthTrack Women series on our website. They and our other women advisors recently tackled the role of prenups in a financial plan. Their next focus is the process of helping new widows make the right decisions in a devastating period.

We hope you will consider our WealthTrack women series as a resource for all of the women in your life.

One of the recommendations we just heard was to buy long term care insurance. It’s been an action point of ours several times over the years as well. But there is a new urgency to this recommendation especially for women because of some big changes occurring in what’s being offered.

So this week’s action point is: explore long-term care insurance sooner rather than later.

According to insurance guru Kim Lankford of Kiplinger’s the premiums for long- term care insurance policies for women are increasingly rapidly, in most cases are much more expensive for women, in some cases more than 50% more costly! It can vary from state to state but more carriers are raising prices and charging more for women because women live longer and therefore tend to require more care.

Lankford’s advice: Get price quotes from several insurers. Check out policies offered by your employer because they may still use unisex rates. Consider buying with your spouse because most insurers offer discounts of about 30% to couples. Consider getting shared benefits.

Lankford says if each spouse gets a three-year shared benefit policy they have six years of coverage between them which they can split any way they want.

For more of our conversation with Maura Griffin and Debbie Taylor go to our website wealthtrack.com and please connect with us on social media as well. Have a great weekend and a wonderful Fourth of July holiday on Friday and make the week ahead a profitable and a productive one.


June 20, 2014

Energy guru, investment banker and author Tom Petrie discusses some of the revolutionary implications of hydraulic fracturing on the U.S energy sector.

Consuelo Mack: This week on WealthTrack, the Energy Revolution! With oil and gas production increasing rapidly in various parts of the country financial thought leader and energy guru Tom Petrie tells us what it means for energy independence, the economy and national security, next on Consuelo Mack WealthTrack.

Hello and welcome to this special energy edition of WealthTrack, I’m Consuelo Mack. Are we in the midst of an energy revolution? Is it possible that the U.S. could become energy independent with all of the enormous economic and national security implications that would entail? Before I discuss those questions with this week’s guest some perspective might be helpful.

Until the recent shale oil technology revolution the common wisdom was that U.S. oil production had peaked in the late 1960’s/early 1970’s. Called Hubbert’s Peak after M. King Hubbert, the oil geologist who predicted it in 1956, oil production, which had been increasing since the 1900’s was expected to peak as known oil reserves were depleted. Until recent years Hubbert’s Peak was believed to be a fact of life. Then came game-changing technology called hydraulic fracturing or fracking, a process that injects fluids, mostly water, under high pressure into horizontally drilled oil or gas wells. That fracking process forces apart or fractures tight rock formations releasing previously inaccessible oil and gas reserves. The difference in U.S. oil and gas production from fracking is huge. In oil alone, the international energy agency predicts production which had been declining for decades will soar especially in desirable light crude from those tight rock formations. The impact on natural gas production is also enormous. By some estimates it is expected to increase 30-40% from current levels. According to independent research firm Cornerstone Macro increased domestic oil and gas production has already had a dramatic impact on energy imports. Imports have fallen by almost half to the lowest level in more than two decades.

This week’s financial thought leader guest has spent over four decades in the oil and gas industry as an analyst, investment banker and advisor to energy companies and governments and has just written a book about it. He is Tom Petrie, chairman of Petrie Partners, a boutique energy-focused investment banking firm and his book is “Following Oil: Four Decades of Cycle-Testing Experiences and What They Foretell about U.S. Energy Independence”. During those forty years Tom has been vice chairman of Bank of America Merrill Lynch. Co-founder and partner of his previous energy investment banking firm Petrie Parkman and in his analyst days was voted number one oil analyst for eight years running in the exploration/independent oil sector by Institutional Investor Magazine. I began the interview by asking Petrie why he believes we are indeed experiencing an energy revolution.

Tom Petrie: This is a period where there are some major game changers going on in the energy supply. What we now have is a situation where the outlook for the next one, two, possibly three decades is much brighter than we thought it was 10 years ago. That’s revolutionary. It’s a game changer because the model for finding and developing new supplies of oil and gas in North America has totally shifted and …

Consuelo Mack: From what to what?

Tom Petrie: From a situation where we thought we were in irreversible decline. That was the mode we’d been in actually for the last three decades.

Consuelo Mack: Right, the Hubbert’s Peak.

Tom Petrie: The Hubbert’s Peak to a mode where we’ve indefinitely postponed that. In fact, we’re going back to…we’re on the way to getting back to the old peak achieved in 1970 for U.S. production of oil and other liquids, and in all likelihood we’re going to have a period of plateau at those high levels for quite a period to come, certainly into the next decade, possibly into the next two decades.

Consuelo Mack: What about gas? You mentioned oil. What about our gas output?

Tom Petrie: That’s even more important. That’s a big part of this revolution as well because gas is actually more environmentally friendly, less carbon, and they supply elasticity is such that the resource potential is 10-fold greater than we thought it was 10 years ago, 10-fold greater. That’s unimaginable prior to some of these new developments.

Consuelo Mack: So that means that we have 10 times more gas that we can produce ultimately …

Tom Petrie: The ultimate potential.

Consuelo Mack: … than we thought we had 10 years ago.

Tom Petrie: That’s right.

Consuelo Mack: You have been following oil, and you write about it in your book, “Following Oil: Four Decades”, and you have written about the fact that we’ve had other big changes occur on the energy scene before that didn’t pan out. So why are you confident that this change, in fact, this shale oil will pan out?

Tom Petrie: The technology that’s come along is very impressive, number one, but most importantly the basic model has changed. The old model, the technical model spoke to the idea that oil or gas is generated in one part of the earth’s subsurface, migrates out of that area into much higher quality rock, the high porosity, high permeability. So it could flow to the surface rapidly. The problem is you had to get the timing right. You had to actually generate it, get the timing right and trap it somewhere else. That’s the product of three probabilities. That’s a one in six chance that you’re going to get what you want. In this case we’re going back to where it was generated in the first place.

Consuelo Mack: So original fields or original … ?

Tom Petrie: It’s called source rock. It’s where it was generated or exactly right next door. We’re not taking this long-range migration notion, and basically for the first 140 years of the oil business and the last 100 years of the gas business, we were working with that old model, but now we’ve drilled most of those cases where it did migrate and was trapped, but now we’ve said let’s go find where the source rock is ubiquitous in a basin, present over a wide area. Let’s go in and with the new technology let’s figure out how to break apart that rock where it’s generated, and as long as the breaking apart takes less energy going in than comes out via multiple, two, three, four, five, six times, then we’ve got a new model.

Consuelo Mack: So it’s economically feasible now with this new technology.

Tom Petrie: Exactly, and this is a revolutionary thing. It took years of innovation by a number of different people. George Mitchell of Mitchell Energy gets a lot of credit for it and deserves because he was persistent in the face of adversity in pursuing it down in Texas near Fort Worth in what’s called the Barnett Shale.

Tom Petrie: Suddenly there was awareness if it works in this shale called the Barnett Shale near Fort Worth, maybe it’ll work in the Fayetteville Shale in Arkansas. Maybe it’ll work in the Haynesville Shale in North Louisiana. What about the Marcellus all through Appalachia? Then within a year, less than a year, 12 other shales were being pursued by the industry, each looking to see whether it would work there. Two thirds of those shales proved to be successful, and today they’re being developed.

Consuelo Mack: So let’s talk about kind of the mother lode of all shale oil development. Is it the Bakken field? Is that what it’s called in North Dakota?

Tom Petrie: Arguably it is because it’s oil up there, not gas, and oil has greater utility right now, but it’s also the Marcellus in Appalachia. The Marcellus in Appalachia has the potential before the end of this decade, probably well before, two or three years before the end of this decade could rival the output of the Emir of Qatar’s gas which is the third largest source of gas in the world. Now it’s not as large a resource, but its productivity is so high that the Marcellus could rival that of Qatar, one of the major gas exporters in the world. To go back to your point, the Bakken …

Consuelo Mack: In North Dakota.

Tom Petrie: … in North Dakota could be somewhere between two and four times as big as Prudhoe Bay in Alaska. Unimaginable 10 years ago. The Eagle Ford in Texas will not be as big as the Bakken, but the productivity of the wells and the proximity to market, economically it’s almost as significant. And then in Colorado we have the Niobrara. Regionally it’s very important for the economy of the Rocky Mountains. So there’s a series of these opportunities now to be pursued, and they’ve now moved from the evaluation stage to the economic development stage, and that’s why I have some confidence.

Consuelo Mack: So the headlines, of course, that we read about frequently are the environmental concerns of fracking. So address that.

Tom Petrie: There are real environmental impacts. Anybody who would argue otherwise you have to wonder where they’re coming from. When I said we want to break the rock apart that takes energy in. It is a process of breaking the rock apart, so you hear about concern about earthquakes. You hear concern about the water that’s being used. You hear about methane leaks. These are all issues that the industry knows about and is looking to address.

Consuelo Mack: And they’re real concerns.

Tom Petrie: They are, and they’re valid concerns. So it does in cases where this development is occurring near housing developments and so on, they will be disturbing to a degree. Now the importance of this is that it’s a relatively short period to actually do it. It’s typically less than 90 days to drill a well. It’s a fairly short period of a week or so in most cases, sometimes maybe two weeks to actually do the fracking, and then they move out, and it’s relatively undisturbed thereafter, but there are concerns. The environmental issues are less some of the asserted ones. For example, the concern about drinking water from an aquifer which is typically less than 1,000 feet into the earth’s surface, and where this occurring typically a mile to two miles in the earth’s surface. Usually there’s quite a layer of impermeable rock where the actual risk of one interfering with the other. The hydrocarbons interfering with the water is very, very low and very manageable.

Consuelo Mack: What are the tradeoffs?

Tom Petrie: In terms of environmental issues, the tradeoffs are that we have to deal with how the water that’s involved in the process is treated. We have to deal with methane leaks. We have to deal with any other environmental impacts that are talked about, but those are the big ones. Return water from fracking can be treated in a way where it’s bio-remediated. That means we eliminate the presence of the fossil remnants that are in that material. There are oil and gas-eating enzymes that can be applied and you end up with water that’s cleaner than drinking water from a bottle of drinking water.

Consuelo Mack: What is your view of the U.S. energy policy if there is one now, and this has been a frustration of yours over the years as well, that we don’t seem to have an energy policy. Do we need one, and what’s the state of it now?

Tom Petrie: Well, all economic policy making in this country is the subject of what can be sold to Congress and then sold to the President who’s going to sign what Congress creates, and as we’ve seen in recent times with a lot of legislation, what Congress creates is … as somebody said, “the definition of a camel is a horse designed by a committee”, and some of our legislation meets that definition. So ideally we want policy that recognizes the economic and technical realities of the situation. What’s interesting about the transformation that we’ve started this discussion with is it didn’t come because of an ideal policy. It came because policy had relaxed to a degree in terms of regulatory constraint, and there was a bubble-up innovation on the technical side that brought forth this new supply elasticity. We’re just coming to grips with that. So hopefully you start with something that’s the equivalent of the Hippocratic Oath. Do no harm. Now when you say do not harm environmentally, it’s one thing. When you say do not harm in terms of supply availability, there’s a dynamic tension there, but the ideal is a policy that recognizes let’s not create artificial constraints on the availability of supply.

Consuelo Mack: What could derail the energy revolution?

Tom Petrie: Well, there’s a couple things. There’s some big decisions to be made this coming election in my state. In the state of Colorado there are a lot of initiatives by those who would like to derail the use of fossil fuels much more radically than is probably going to occur naturally over the balance of this century, and so there’s initiatives that would say let’s have local decisions on whether you can frac or not. It turns out the local decisions at the town level, the municipal level certainly appeal to those who like NIMBY-“not in my backyard”, but the nature of the resource is a very valuable resource for all the citizens of a state. So Colorado is a good test case of this. Basically the potential is probably three to five billion barrels of oil that could be developed over the next one to three decades. The economic benefit of that would be probably half a trillion dollars. That’s a large number. We’ve learned to talk in trillions post the financial meltdown, but a half a trillion in the state of Colorado, there’s no close second.

Consuelo Mack: Alone.

Tom Petrie: There’s no close second. This is not a Hertz and Avis. It’s Hertz and the next one is mom and pop rental car, and so that amount of economic benefit to be constrained because each and every community chooses to say we don’t want it in our backyard is a big, big decision. So there are a lot of things that come from that.

Consuelo Mack: People are talking about the U.S. could be energy independent in the foreseeable future. Is that a likelihood?

Tom Petrie: I’d say it’s a worthy goal. Barrel for barrel independence is not critical. It’s more important that we actually achieve a workable connection in the global markets, and the term I would rather use is energy secure, and you get to energy security well short of being barrel for barrel independent. We’re still consuming 17, 18 million barrels a day even today with conservation down from a high of 21 million barrels a day, and maybe on its way to 15. We’re at eight million barrels a day of production, on its way to 10, 11, maybe 12. At 11 or 12 million barrels a day with growing gas production and exports and with this improvement in the balance between what we could export in the way of high-value oil and import lower, we would be highly energy secure in my view at something like 11, possibly 12 million barrels a day, and I think that’s a much better goal than the idea of saying, well, if we’re consuming 15, we’ve got to produce 15.

Consuelo Mack: The investment implications for this energy revolution. How do we make money from this?

Tom Petrie: Well, number one, it’s happening as we speak. In our markets you hear things about an improved manufacturing capability in the United States. One of the biggest areas where we still have a competitive edge bar none over the rest of the world is in our development of technologies to exploit oil, and it’s been a competitive edge for years, but the new innovations are largely occurring here, and the manufacturing of equipment to do it are largely occurring here. Some of the very best drilling technology exists in the United States, some of the innovations you see. I’m on the board, full disclosure. I’ve been on the board of Helmerich & Payne. Helmerich & Payne has come up with innovative drilling technology that has cut drilling time and improved penetration rates and reduced drilling costs dramatically, and their capabilities then have knock-on benefits to the likes of Caterpillar and a whole lot of other manufacturers of the equipment. So we’re seeing a broad capability in the oil service arena with job creation that goes way beyond the people who are on the site drilling the well, and that’s going to continue. Most of these innovations are causing foreign companies to come here to learn about this.

Consuelo Mack: So you are no longer an oil analyst. You have been an investment banker for a long time, so you cannot recommend individual companies.

Tom Petrie: That’s right.

Consuelo Mack: But who are the major players, Tom?

Tom Petrie: In categories, number one, the upstream sector still matters, and it’s the most important. So the better positioned companies in the upstream sector.

Consuelo Mack: Upstream meaning …

Tom Petrie: Meaning the companies that are involved with raising the capital and putting it to work to develop new sources of production in the major plays in the Bakken formation of North Dakota, in the Eagle Ford formation of Texas, in the Permian Basin of Texas. Those three big areas are the ones that are going to develop three to four million barrels a day in the U.S.

Tom Petrie: Secondly, there’s the service sector and all the big names.

Consuelo Mack: Oil service.

Tom Petrie: The oil service sector. All the big names in the oil service sector are very focused on what they’re doing to develop that.

Consuelo Mack: The drillers, the …

Tom Petrie: These are partly drillers, partly fracking companies that specialize in analyzing and developing techniques to frac and develop those resources. Those names are well known, so these are not recommendations, but they’re the large capitalization such as Schlumberger, Halliburton, Baker Hughes, et cetera. Those are the companies that specialize in figuring out how to go down there, break the rock apart, do it economically and turn it over to the upstream companies. Now there’s another great set of opportunities and that’s in the midstream. Most of the midstream sector lends itself to companies that are involved with pipelines and involved with gathering systems, and much of that fits into the MLP category, and there’s a whole class of …

Consuelo Mack: Master limited partnership.

Tom Petrie: That’s right, master limited partnership yield companies, and those are situations where that’s another category worth looking at if an investor is looking for yield with some growth, and each of those have a lot of merit.

Consuelo Mack: You have investment rules that you have developed over the last 40 years for investors who want to invest in energy. Number one, why should we invest in energy as investors and energy companies?

Tom Petrie: We should invest because energy is one of the main drivers of economic growth throughout our economy, throughout the global economy, and it’s demographically driven. We’re in a world today of seven billion people. When I was born, the planet had two and a half billion people, so we’ve almost tripled. Between now and 2030 we’re going to add almost another billion people. Between now and 2050 we’ll probably add two and a half billion people. So the demographics are a big, big part of that. The other part is economic growth doesn’t occur without some degree of energy growth, and so that’s a compelling reason to be represented in this sector. That said, it’s also cyclical and it’s my number one rule, and we have to keep that in mind. It’s also geopolitically driven. There are times when geopolitical events overwhelm us. That happened in 2008 and ’09 when we had the financial meltdown. Oil went from 147 to $35 in less than a year. It didn’t stay there. It’s powerfully self-correcting, and we will get those times again, so the other rule to remember is the time to buy is when everybody hates it, and right now we’re in a sweet spot. It’s fine. It’s not at the high. It’s not at the low, and I think there will be opportunities in the sectors we talked about, but if I had one area today to focus on, it would be natural gas because we’ve got probably more of a tailwind than a headwind on pricing, and we’ve got supply elasticity that is 10-fold better than it was a decade ago.

Consuelo Mack: One investment for a long-term diversified portfolio. What would you have us all own some of?

Tom Petrie: Some representation in upstream natural gas, one of the better suppliers of gas. Again, I can’t make individual recommendations, but that’s the fertile area today. You can be a contrarian in gas. We’re less than two years away, about a year and a half away from opening up U.S. deliverability of natural gas to the global market. That is going to be transformational. It’ll be very rewarding to companies that help provide that connectivity and that also reach back into the producers of the gas in the major basins.

Consuelo Mack: Tom Petrie, you’ve had a fascinating career which is in your new book, “Following Oil”, which is going on the WealthTrack bookshelf recommendation list, and it’s also great to have you back in the investment banking business with Petrie Partners, so thanks very much for joining us, Tom.

Tom Petrie: Thank you. Good to be here.

Consuelo Mack: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is: read Tom Petrie’s book “Following Oil”. If you are invested in energy stocks and most of us are either actively or passively, and are interested in an extremely knowledgeable insider’s view of the events that have rocked and shaped the oil and gas industry over the last 40 years this is the book for you. Tom covers it all from his extremely well connected vantage point of energy analyst and advisor to major industry players as well as policy makers and regulators. He also provides a rational and realistic view of how to balance the growing energy, environmental and national security concerns we face. “Following Oil” is being added to our WealthTrack bookshelf.

Next week we will be starting our tenth season of WealthTrack and we are doing so by helping the women in our lives achieve financial security. Two of our award winning WealthTrack women financial advisors will give us advice on how to build a financial plan that works in different stages of our lives. We will also discuss the role of prenups in the WealthTrack Women section of our website.

Have a great first of the summer weekend and make the week ahead a profitable and a productive one.


May 30, 2014

On this week’s Consuelo Mack WealthTrack: a Great Investor who has made his name investing in small company stocks explains why he now favors large companies. Charlie Dreifus, the portfolio manager of the Royce Special Equity funds discusses where he is finding the greatest values in the market now.

CONSUELO MACK: This week on WealthTrack, they say the best things come in small packages but Great Investor Charlie Dreifus says the time to think big is now. The noted the small company stock manager explains why he has closed his small cap fund to new investors and has opened to large caps in his Royce Special Equity Multi-Cap Fund. A rare interview with Charlie Dreifus is next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. They say the best things come in small packages and that has certainly been the case in the stock market in recent years. Looking over the last decade for instance, small company stocks have outperformed large company ones by a significant margin delivering 10.4 % annualized returns versus 7.1% annualized returns for large cap ones. Last year the performance gap was also huge. The Russell 2000 Index, considered the benchmark for small stocks advanced 38.8% whereas the widely followed S&P 500 lagged with a 32.4% return. And not only that, by several measures of value including price/earnings multiples, small stocks look expensive. Five years from the market’s 2009 bottom and clearly in a bull market where are the best stock bargains to be found? That is a question value investors ask themselves every day. However few portfolio managers are interested or able to stray from their area of focus or expertise.

This week’s guest is an exception in both desire and ability. Three years ago he made a decision to expand his long-time concentration in small company stocks to include large ones as well. He is Great Investor Charlie Dreifus who for the last 16 years has made his name managing the Royce Special Equity Fund, which is a value oriented small and micro-cap fund that has beaten its benchmark the Russell 2000 index since inception with less than market volatility. In 2010 Dreifus launched another value oriented fund, but this one was not in small caps and never will be. It is the Royce Special Equity Multi-Cap Fund and it is emphasizing large cap stocks right now. It has also beaten its benchmark, the Russell 1000 since its inception three years ago.

Why did Dreifus want to go big and how did he convince his boss, legendary small cap pioneer and fund manager Chuck Royce to let him do it? Dreifus says although he was managing small he always kept an eye on the big boys.

CHARLIE DREIFUS: Large caps did extremely well from 1982, August of 1982 into March of 2000, and I think the S&P numbers roughly about 18% compounded over that period of time for 18 years, and for 100 years including that time period it’s roughly nine percent, so way over achieved. So it was sort of regression to the mean. Even if the financial crisis hadn’t happened, the likelihood that those stocks were to underperform, and so you had the confluence of an asset class that was overvalued coming into the decade with some concerns, and particularly one of the concerns to this very day in these large stocks is their international exposure and specifically their emerging market exposure. It used to be thought of as a positive. These days it’s thought of as a negative. So the valuations were attractive. I did some of my metrics to just sort of test and see. Is my perception substantiated by the figures? Ultimately everything rests on the numbers. Okay?




CHARLIE DREIFUS: Right, so I went to Chuck and asked him what his thoughts were about us launching a large cap fund.

CONSUELO MACK: I can imagine the reaction you got.

CHARLIE DREIFUS: Yeah, it wasn’t positive, although he didn’t rule it out entirely. He said, “Let’s think about it.” So I thought about it a couple of days, and I went back to him, and I said, “Well, how about this? If you have no problems and I go to Compliance and they have no problem, would it be okay with you if I started buying some of these and did some real research for my own account?” and he said, “Absolutely. Fine. Go do it.” And it turned out I found names and I started making money.

CONSUELO MACK: For your personal account.

CHARLIE DREIFUS: For my personal account.

CONSUELO MACK: Right, in large caps.

CHARLIE DREIFUS: With the blessing of the firm in large cap, and so I went back to Chuck, and I showed him the results, and I said, “You know, the values are still there”, this is 2009 and early 2010. We launched the fund December 31, 2010, ultimately.

CONSUELO MACK: Right. This is the Royce Special Equity Multi-Cap Fund.

CHARLIE DREIFUS: Which just celebrated its third anniversary, therefore.

CONSUELO MACK: And it’s beaten the market. It’s gotten great returns three years. Congratulations.

CHARLIE DREIFUS: Thank you, thank you. So yeah, three years is a short period of time, but we’re encouraged by what we’ve seen. So I kept on working with Chuck, and he kept on saying, correctly so, “Remember, we’re a small cap shop,” largely, and so we finally came up with a name for it which is multi-cap. It’s not all cap. Multi-cap, the distinction there is basically the lowest market cap area generally will be $5 billion, so things below five billion will most often be excluded from the multi-cap portfolio, but it has no upper cap. So it’s a matter of public record, there are names in the portfolio such as Microsoft and Intel with …

CONSUELO MACK: Very large cap.

CHARLIE DREIFUS: Very large caps, and there are some in the portfolio with five to fifteen billion dollar market caps. The average weighted one is in the 40 to 50 billion dollar which is still by most measures large cap.

CONSUELO MACK: But why? It was a valuation.

CHARLIE DREIFUS: It was a valuation.

CONSUELO MACK: You decided you’re a small cap manager, has been for 15 years, and you’ve decided looking at the valuations that small caps had done well and large caps had lagged, so that was… it was a macro call then, right?

CHARLIE DREIFUS: It was, but I also always… I take my responsibility as everyone at Royce does, and I’d like to believe most in our industry do. I’m a fiduciary to my clients, and whether it hurts my wallet or not, I have a duty to give them my best advice, and if that means suggesting that a different asset class is better, or if that means reducing our fees, or that means shutting the product down, we have to do it. I should also mention we just, on that basis, we now have about $185 million in the multi-cap product, and I went to the board and asked them to reduce the fees. We reduced it from 100 basis-point management fee to 85 basis-points management fee recently.


CHARLIE DREIFUS: As of January 1st actually.

CONSUELO MACK: Thank you. I mean, I appreciate that as an investor, and I might add along those same lines that the Royce Special Equity Fund which is your small blend fund, you closed it to investors in 2012.

CHARLIE DREIFUS: Two years ago.

CONSUELO MACK: And the reason was?

CHARLIE DREIFUS: The capacity issue. I just couldn’t find… I mean, we could take in more money, but it wouldn’t serve the clients good. It would help Royce and Charlie Dreifus, but in the long run it wouldn’t really help Royce and Charlie Dreifus because we would tarnish our reputation for being good stewards. It’s the second time I actually closed my Special Equity Small Cap Fund, and it’s the confluence of monies coming in, selling securities and the process that I use for multi-cap is the same process that I use for small cap, and part of that is quantitative, and part of it is qualitative. The quantitative, the first and foremost is valuation. Rate of return is a function of entry level, and the math is the math, and the market in general, not only small stocks, large stocks also, it’s elevated. There’s no arguing about that. Okay? The point is, can it go higher, and I believe it can. Perhaps we’ll have time to explore that.

CONSUELO MACK: Well, so let’s talk about that. Let’s talk about your outlook for the market, which you turned really bullish when?

CHARLIE DREIFUS: About a year ago.

CONSUELO MACK: So when? In January of 2013?

CHARLIE DREIFUS: January. Correct.

CONSUELO MACK: And why are you really bullish about the stock market, and large caps in particular?

CHARLIE DREIFUS: Well, I was doing a marketing trip, and I was speaking as I am with you, and as I’m doing the marketing trip, I get more and more bullish, and at the last meeting I sort of yell out, “This is a melt-up. I’ve seen this movie before,” and fortunately, because I’m known traditionally as being ultra conservative. I think I shared with you. Chuck once gave me a portrait of myself wearing belts and suspenders. I’m a cautious individual.

CONSUELO MACK: Prove it. Right.

CHARLIE DREIFUS: So there are several factors at work. Number one, relative to the world, we’re just in a great place.


CHARLIE DREIFUS: The U.S. is. We have natural population growth. We have an abundance of everything, increasingly so. I mean, we all know about the energy renaissance and how we’re going to be exporting petroleum and probably the largest energy producer in the world. The manufacturing renaissance, the fact that we’re re-shoring, companies coming back but, more importantly, case after case of foreign companies coming here. BASF, the old German chemical company, 150 years old, is moving chemical plants to the United States because the cost of natural gas is a third of what it is in Europe, plus the regulations are so much easier. The other thing is we’re a consumer economy, so having said all of this, our exports run 15 percent of our economy. We’re not Germany. We’re not Japan. Yes, it’s good to do exports, but if for some reason we couldn’t, it wouldn’t hurt us, and half of those exports actually are agricultural, so they’re probably not at risk.

CONSUELO MACK: And there’s another aspect of this which you had talked to me about that you have a theory that companies’ profitability as the economy improves, that their profitability can really accelerate. So what is that theory, which is a really long-term trend as far as you’re concerned, could be?

CHARLIE DREIFUS: Yeah, I’ve noticed of late that many companies, particularly in the industrial sphere and sectors, are showing on flat or down revenues higher operating margins, percentage of earnings. And now there can be the accountant in me is cynical enough to say yes, well, we all know companies have not spent enough on capital expenditures, so deprecation which would be included in those costs are down, so they’re benefiting from that, or because we’re having sort of low inflation which is also a cause for bullishness, incidentally, that low inflation is aiding companies in the sense that they expected raw materials to cost more than they have, and so they’re getting a pricing benefit. They’ve priced for a higher cost, and they’re not having to expend for higher costs, but when I dig deeper and what some people describe as unique to me and probably unique, therefore, in my multi-cap space because I don’t bring much else unique to my multi-cap space, is my deep diver intuitive.

CONSUELO MACK: Right. Your deep dive accounting, your accounting cynicism, but the deep dive into the numbers.

CHARLIE DREIFUS: The numbers, correct, and the deep dive in the numbers, and this goes across asset classes. This occurs in small caps and large caps these days, but on the point we’re talking about, this incremental margins is a sign, if it’s not due to those two factors that I have mentioned, it’s a sign that the cost structure had changed, that the break-evens have been lowered so that once we do start getting higher revenue, and the economy seems to be on traction, people, as we’re speaking now, everyone’s in the process of arising their fourth quarter real GDP. It’s come up from…

CONSUELO MACK: Right. It’s going up.

CHARLIE DREIFUS: It’s going up. It’s come from like two percent to three percent of late. Well, you add one percent or two percent for inflation. You’re starting to get some real nominal GDP. Once GDP goes above five percent nominally …

CONSUELO MACK: Nominal. Right. That’s including inflation.

CHARLIE DREIFUS: Inflation. Then companies will probably have decent revenue growth, and a good portion of that will fall down to earnings per share, profits, and what the market may be saying to us, yes people, the market is elevated on current numbers, but looking out a couple of years, I don’t know. Is it two years? It’s not … I doubt it’s in 2014. Okay? And therefore, frankly, I’m not willing to pay for it. You know, the numbers are the numbers. I buy on reported earnings or lower future earnings. I don’t prepay in either of my funds for future earnings.

CONSUELO MACK: No, I think you said that you want to pay zero for expectations.

CHARLIE DREIFUS: Correct. I want to crunch out expectations from my stocks, because that’s a way I’m trying to make my clients absolute money, and the way to do that is to buy absolute value.

CONSUELO MACK: Give us some examples of where you’re finding absolute value in the large cap space.

CHARLIE DREIFUS: Okay. It often is in areas that are unpopular, and that’s true. I work in the area of anomalies in efficiencies, and the first way to assess if a stock or a whole sector is out of fashion is to run a screen. I use and at Royce we generally use a valuation metric which is a cap rate, the return the buyer would get if they bought the whole company, and I compare that to what I think my cost of capital would be, again, as a private equity or a strategic buyer would. There has to be a spread. There has to be … I have to earn more than it’s costing me. So these days retailing, which there’s a lot of controversy about, and retailing has been controversial now for a couple of years, but I keep on reminding people there is something unique in American DNA. We’re shoppers. Okay? And we’re a consumption economy.

CONSUELO MACK: So a company, for instance, that exemplifies the Royce and the Dreifus approach, a retailer would be what company that you own?

CHARLIE DREIFUS: Well, in the large cap space it would be Nordstrom.


CHARLIE DREIFUS: Nordstrom I think is misunderstood or not fully appreciated. Most people know of them for the service they provide in their stores and fashion. It’s not a full department store. You don’t buy refrigerators at Nordstrom, but they have somewhat of a niche somewhat on the higher end level, of course, but what people have not given them credit for is, first of all, their earnings have been under some pressure because they have developed a very robust, multi-channel approach to retailing. They have this off-price division called The Rack. They have a lot of boutique kind of acquisitions they’ve made which got them into more product but, more importantly, got them expertise in communicating with their customers, and they’ve said publicly that, you know, they’re somewhat concerned 50 years out whether people will be going to malls.


CHARLIE DREIFUS: And so they’re on the cutting edge of all of this, and that’s costly.

CONSUELO MACK: And cutting edge of online shopping as well that they’re developing.

CHARLIE DREIFUS: Right, right, right, and the fact that you can buy it online, return it at the store, you know, just making it a seamless transaction, taking all of the negatives out of online shopping.

CONSUELO MACK: You’re finding things in a Nordstrom, for instance, that you think your competitors are missing, and so the deep dive accounting shows you what?

CHARLIE DREIFUS: What I found, among other things, in Nordstrom was the fact that unique these days wasn’t in the past, but unique these days is that Nordstrom with total assets of eight, nine billion dollars, has over $2 billion of credit card receivables that they own. In other words, if you have a charge account at Nordstrom, Nordstrom is carrying that and has to finance that, but it’s a matter again of loyalty, closeness to the customer. You could go out if you wanted to and sell that portfolio. Obviously, you would get above par. You would get above the stated value, because this is a very high- quality portfolio that people would want, and they would get a serving fee. They would get a residual, so to speak, off of those credit card receivables even if they didn’t own them, if they sold them to a third party.

CONSUELO MACK: That’s something that you’ve seen.

CHARLIE DREIFUS: That’s something that I have never seen people really mention. The other thing that people don’t mention is that Nordstrom, which some retailers do also … they’re not totally unique on this … they own 22%, 22% of their stores are on company-owned land and stores.

CONSUELO MACK: So you’ve got the real estate value as well.

CHARLIE DREIFUS: Real estate. Well now, there’s another significant portion where they own the store but not the land. They may have options to buy the land, but 22% of the portfolio is all theirs. There’s a value. There’s a comfort level. There’s a financial anchor as I describe it that I don’t think people really look at, and my experience is when you buy companies that have this absence of expectations … no one’s hyping it. Quite the contrary; no one cares. Okay? That’s where the opportunity strikes, not always and not in every case, but in a portfolio it seems to work out.

CONSUELO MACK: Charlie, one of the things that we haven’t talked about, and that is how important dividends are in your process.

CHARLIE DREIFUS: Well, dividends are important. They’ve always been important. I actually did an academic paper many years ago, because if any asset that throws off more income, everything else being equal, is more valuable, and so what I have focused on in recent years are companies that have a tendency and ability … that’s the most important thing, the cash flow, the cash conversion cycle is such that they can raise their dividends with no fear of having to reduce them subsequently, and the companies that do this over long periods of time are called dividend aristocrats. That’s generally a term that’s used for companies that do it more than 25 years or so, and what I believe, and it’s interesting, these don’t provide high yield. Most times it’s an adequate yield, but it’s not a high yield.

CONSUELO MACK: So it’s a growing dividend stream is what you’re looking for.

CHARLIE DREIFUS: it’s a growing dividend stream

CONSUELO MACK: Right. And that’s going to lead me to the next question which is the One Investment for long-term diversified portfolio. So what is it that we should all own some of in our portfolios?

CHARLIE DREIFUS: Well, and I’m going to mention a concept and then two names, and I do personally own both of these two names, although I’m looking for more venues, more product that offers this kind of yield that I’m going to talk about. The two, these are dividend growth ETFs, and the two that I would like to highlight but I encourage your viewers to do their own research and find some more … there are a lot of them … are the SPDR S&P …

CONSUELO MACK: Dividend ETF. Right.

CHARLIE DREIFUS: Dividend ETF. The symbol is SDY, and the other is the Vanguard Dividend Appreciation.

CONSUELO MACK: Dividend Appreciation.

CHARLIE DREIFUS: VIG, and both of them, you know, have decent yields. They’re constructed around that index so there’s little, if any, active management, but they have a history of owning the companies. There are, as of today, 18 companies in the United States that have raised their dividends for 50 years or greater consecutively. You can own them all if you don’t do the deep dive into the accounting and if you’re not cognizant of valuation.


CHARLIE DREIFUS: So interestingly, with all of those caveats and metrics that I use, nonetheless seven of those are in my multi-cap fund, and one is in my small cap fund.

CONSUELO MACK: Charlie, thank you so much for joining us on WealthTrack. Thanks Charlie.

CHARLIE DREIFUS: My pleasure, I’d love to come back.

CONSUELO MACK: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point picks up on Charlie Dreifus’ theme of investing in companies that have a history of growing their dividends. It is: invest in growing dividend streams. Historically dividends have contributed at least 40 percent of stock returns. And as Dreifus said, all other things considered, income makes an investment more valuable.

There are many products available to participate in growing dividend stories. Dreifus just recommended two ETFs: The SPDR S&P dividend ETF that holds all stocks in the S&P 1500 that have raised their dividends every year for the past 20 years. There are about 80 of them. And the Vanguard Dividend Appreciation Index ETF which focuses on U.S. firms that have raised annual dividends for at least 10 years. Among the mutual funds specializing in dividend growers are two that come highly recommended by both Morningstar and Barron’s. They are the Vanguard Dividend Growth Fund and the T. Rowe Price Dividend Growth Fund. It is worthwhile putting the power of increasing dividends to work in at least a portion of your portfolio.

In the meantime to see past shows and additional interviews done exclusively for our website’s Extra feature please go to wealthtrack.com. And for those of you on Facebook and Twitter we look forward to connecting with you. Have a great weekend and make the week ahead a profitable and a productive one.


May 23, 2014

Steven Romick, Morningstar’s 2013 Allocation Fund Manager of the Year on why he is holding large sums of cash in his FPA Crescent Fund.

Consuelo Mack: This week on WealthTrack, Why is Great Investor Steven Romick hording mounds of cash and other safe, money type securities in his award winning FPA Crescent Fund? Contrarian Romick explains why he isn’t putting his cash to work in the market, next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. Holding cash is considered by most professional investors to be one of the worst investment choices you can make right now. It yields next to nothing, as it has for the last five years largely because of Federal Reserve and other central bank policies that have kept short term interest rates at record lows. And when inflation is taken into account cash is actually a money losing proposition. There is however a small minority of investors who value cash and are not afraid to hold large amounts of it and its equivalents when conditions warrant. Warren Buffett is probably the most famous among them.

This week’s Great Investor guest is also one. He is Steven Romick, lead portfolio manager of the five star rated FPA Crescent Fund which he launched more than 20 years ago. Romick and his team were named Morningstar’s Allocation Fund Manager of the Year in 2013 because of their “capital preservation and strong stewardship which helped the fund achieve its goal of delivering equity like returns with less equity risk over the long haul.” Since its inception this go anywhere, invest in anything fund has delivered better than 11% annualized returns besting the stock market and its balanced portfolio benchmarks by substantial margins. Romick, a proud, self professed contrarian value investor has been a vocal critic of the Federal Reserve’s unprecedented monetary expansion and has become increasingly wary of the rich levels of prices in markets around the world. In quarterly letters to clients he has pointed out several indicators of just how expensive markets have become. One of the most dramatic is this chart sent to clients in his last annual letter showing stock prices as a percent of GDP. As you can see the value of stocks was worth more than 200% of the economy’s total output of goods and services rivaling the market peaks of the dot com bubble. As the markets have appreciated in recent years Romick has been reducing his stock and bond exposure and raising his cash positions to the second highest point in the FPA Crescent fund’s history. I asked him why.

Steven Romick: We’re not that optimistic. It’s not that we’re pessimistic. I don’t want to confuse the two. It’s not a target rich environment, and multiples in the market are higher than average, and there’s real risk out there from central bank action. How it all ends, we don’t know. We don’t know with all the trillions of dollars that have been used in some type of academic arguments, but hopes that it alchemizes into reality has yet to be seen. So we don’t know we’re going to have inflation, if so, how much, when? We don’t know if we’re going to have deflation. If so, you know, when that might occur. And so we have a portfolio today that’s kind of betwixt in between and we’re trying to create it in such a way that it’s robust in more than one scenario, because we have the ability to do more than most. One might say we have more than one way to lose money because of that, but nevertheless, we like to look at it as opportunistically as we can and say we can buy common stocks, preferred stocks, junior debt, senior debt. We can buy containerships, we can invest in different parts of the world, and it gives us a lot of opportunity to lift different kinds of things. When we look across the world today where we have zero interest rate policy in so many of these developed economies, it pretends to convert capital allocation decisions, and as a result asset prices get lifted and we find less opportunity than we have historically found. So at the end of the day, price is going to be our guide. And so you can have a terrible outlook, but as long as the assets you are considering purchasing have that bad outlook priced into them, then it’s fine. So the problem we have today is we have concern about the future for some of the reasons I mentioned, and yet the assets aren’t really taking that into account. So the risk reward for individual investments on a micro basis are not terribly attractive. So cash builds for us as a byproduct of what it is that we do, not as a top-down. “Oh, the world’s expensive so let’s go have a lot of cash.” One thing I’m confident in today is that there will be greater volatility in the future than there has been most recently.

Consuelo Mack: Right. Because we’ve had very low volatility. Why do you think there’s going to be more volatility?

Steven Romick: Well, there’s never been a point in time in history where governments have been able to really get together and say, “Hey! Let’s go and manage the economy by doing all of these things.” We’ve got a four trillion dollar, you know, fed balance sheet that has to contract at some point in time.

Consuelo Mack: So we’re seeing a gradual pullback, at least in this country, and yet volatility has not increased. So is it possible that we could have kind of a soft landing of the withdrawal of central bank easing?

Steven Romick: Sure, everything’s possible. I mean, Kermit the Frog married Ms. Piggy. Nobody thought that would happen. (Laughter) So yeah, anything could happen, although I think it’s unlikely. I think that, you know, we’re challenged by the idea that the government can really manage this in such a way. And you spoke to contraction and quantitative easing, and we haven’t had any great effect yet. However, it’s really a three part process, because we built up the balance sheet, so now what we have to do is A, they’re going to start by reducing asset purchases. Then second, they will stop asset purchases, and then third, they’re going to have to find somebody else to re-fly out the balance sheet as the balance sheet unwinds as those loans that they purchase, or whatever it is they purchase, you know, come due. So there’s a lot that still is yet to come, and we know with quantitative easing is something none of us even heard of a decade ago or ever thought about, and now we’re depending on it. It’s a little bit like we know we’re addicts. I mean, my partner Bob Rodriguez calls it Red Bull Economics. You get all jacked up on the Red Bull and then anything can happen.

Consuelo Mack: How are you managing your cash now versus what you would have done traditionally?

Steven Romick: Well, in the past we were more commercial paper with a little bit of US treasuries, and then as we got into 2008 we started backing away from treasury securities. And we really focused more on US treasuries, just because we weren’t getting paid to play, we weren’t getting paid in the risk, there were too many questions out there, and we questioned the treasury function in some of these companies. It wasn’t an analysis we wanted to make at the end of the day. We wanted to analyze businesses and know that we were buying those businesses or assets at good discounts to what the underlying value was to give us the margin safety, if you will. And we didn’t want to have to make that analysis in the case of commercial paper, so it was a why bother? They’re not getting paid for an equity rate of return so let’s just not worry about it, so we owned US treasuries. So since then we have less of that concern, so commercial paper has come back into the portfolio, and we’ve also gone overseas into certain other …

Consuelo Mack: Some sovereign debt, right?

Steven Romick: Some sovereign debt, and we’ve actually hedged out some of their currency risk, but we still have the sovereign risk, but we’ve actually been able to, in the one case we’ve really done it, in any kind of size been able to actually get higher rates of return than we could even after hedging out the US dollar.

Consuelo Mack: Which is in Australia?

Steven Romick: Singapore. Nearby.

Consuelo Mack: So why are US treasuries no longer the most prudent course?

Steven Romick: Well, for us it was just a question of we think that there’s other places you can do just to protect your capital. I mean, the US treasury market, we didn’t think anything was likely to happen, but you know, in this case diversify is a good thing.

Consuelo Mack: You’re a contrarian investor and you’re very proud of that fact. So are there any contrarian investments out there now that are catching your eye? You know, where else is there to go but cash?

Steven Romick: There have been a few places we’ve been finding to invest in. The problem has been, the reason why cash is built, there hasn’t been enough to create a whole fully invested portfolio. So in the last six, nine months we built a position in the aluminum industry. Aluminum is trading at an historic low, inflation adjusted low, particularly since such a large percentage of the cost of aluminum … aluminum production or energy, and energy costs are a lot higher today than they were a decade ago.

Consuelo Mack: So I know Alcoa, for instance, is one of the …

Steven Romick: And Alcoa is an interesting one because everybody who follows Alcoa, the Wall Street analysts, are metals and mining analysts, and what tended to get lost in looking at Alcoa was that the largest portion of its value was not the stinky, smelly, polluting aluminum business, but was the engineer product solutions business where they are really one of only two people in the world to manufacture these aerospace suppliers, you know, with these highly engineered products that really don’t use much aluminum at all. I mean, more than 90 percent of it are specialty alloys and titanium, so Alcoa, you know, as an aluminum company, it’s most valuable division does very little in aluminum. And people weren’t valuing that correctly, because the wrong people were looking at it. And so that gave us an opportunity to invest in Alcoa back last fall, and we were able to … what we viewed at the time, given the terrific value for the engineering product solutions business whose largest competitor is Precision Castparts … you know, Precision Castparts at the time traded 14 times EBITDA, and we weren’t going to even apply multiples like that to this business, even though we would argue it was as good or is as good as Precision Castparts business. Even at a discounted value, we had a huge option on the turn of aluminum. You know, we didn’t know what aluminum would turn. Will it turn? Will it turn? But we do know that half of the capacity in the world is losing money, so only half of the aluminum in the world actually makes money today, so you either need to see supply, contract, which is happening, Alcoa is closing its melting capacity today as well, or you need to see terrific demand growth, and we are seeing demand growth as well. If you look at the back log for airplanes, for example, it’s an eight year back log, about as high as it’s ever been, and they’re big users of aluminum for skin and other parts of the airplane, as well as you see it really at the margin move in the automotive industry. So you can think of examples in GM or Ford where you see increasing amounts of aluminum use. They’re putting 300 pounds more of aluminum in a Ford F150, which will save 1000 pounds of steel, which makes these cars lighter, easier to handle, and also makes these cars more apt to meet EPA requirements.

Consuelo Mack: How does Alcoa Aluminum get on FPA Crescent’s screen?

Steven Romick: Well, we can thank Brandon Stranzl for Alcoa specifically, who’s on our team.

Consuelo Mack: One of your research analysts?

Steven Romick: One of our research analysts. And, you know, the way he got to it … look, we’re in the business of looking for bad news, in very simple terms. So whenever you see stocks that are making new lows or you see headlines that say, “Well, you know, aluminum is dead. Aluminum pollutes. You know, aluminum capacity closing. Alcoa in trouble. Versall(?) in trouble.” I mean, you see those kinds of headlines, we say, “Hmm, there’s lots of bad news. There’s probably natural sellers, so maybe we can go and take advantage of that.” One of the things that we bring to the table, we believe anyway, is time arbitrage. We’re very patient as investors. We patiently wait for the opportunities that we’ve patiently researched, and we patiently wait for those opportunities to work out. So the bad news today is not unrealistic. It’s fair. I mean, the aluminum business is challenged today. However, we’re comfortable looking out a number of year, and it won’t be as challenged in the future. And so if we’re patient and we can wait for that opportunity or the valuation to reset, you know, down the road, and as long as we can get what we feel is a good IRR between now and then, we’ll look to go in and invest in those kinds of businesses.

Consuelo Mack: So do you tiptoe in? Do you gradually build positions?

Steven Romick: Sometimes.

Consuelo Mack: Or it just depends?

Steven Romick: Sometimes we have to get to know the business better over time. It takes time to get to know these businesses. Sometimes we have a very strong understanding at the get go, or we’ve invested in that business before. At the end of the day it’s a combination of understanding and price. Understanding, conviction and price, I should say.

Consuelo Mack: Looking around the world, where else is everyone running from?

Steven Romick: I don’t know they’re running from a lot of places. I mean, there’s not a whole swath of businesses that are out of favor.

Consuelo Mack: Well, they’re running from the emerging markets, for instance.

Steven Romick: Right, but emerging markets are …

Consuelo Mack: Russia.

Steven Romick: Yeah, emerging markets in general are areas that the multiples have contracted a bit and stock markets have declined in emerging markets. However, more of that decline has really been the result of commodity based companies, more cyclical companies and finance companies. And these are businesses that we aren’t as interested in in many of these markets.

Consuelo Mack: Because they’re just too cyclical?

Steven Romick: We prefer on average doing a higher quality business. And in the case of Alcoa, the aluminum smelting business wouldn’t be as high quality. The EPS business, that engineering product solutions business is very, very high quality. So we want to own these higher quality businesses, and the higher quality businesses in emerging markets aren’t trading at big discounts. You mentioned Russia. We have a small stake in Russia. I mean, Russia’s interesting, because it’s obviously quite combustible over there right now, and it’s unusual because people are running in fear, and when looking at Russia, you can look at a lot of companies that are actually of strategic importance to the state as well as to the globe. So something you couldn’t say about Venezuela, for example. There might be businesses that are important to the state, but not as important to other countries around the world.

Consuelo Mack: Right. I mean, they’ve got these giant energy producers, for instance.

Steven Romick: Exactly. They’re the largest, the largest hydrocarbon producer in the world, and as far as public companies are concerned, they have the largest reserves in oil in Rosneft and the largest reserves, as you mentioned, in Gazprom in gas. And it’s of strategic importance to the state because energy accounts for 25 percent of Russian GDP. It’s 50 percent in Russia of their annual revenues, and representing its strategic importance to the state and how important it is to their neighbors, it counts for 60 percent of their exports. So we understand that there’s risk there. However, these companies are trading at very large discounts to other companies of their ilk. You know, in Exxon, for example. So these large discounts, you know, justify the risk of owning some of these companies in Russia, which has an uncertain future. Not that Russia’s future is so uncertain over the long term, but shorter term those correlate some questions, but that’s what created again these natural sellers which allows us to come in and do some buying. But what’s interesting about looking at Russia is that people there seem to be less concerned. There’s massive insider buying in some of these companies. In the last 12 months in Lukoil, for example, there’s been a billion dollars purchased from insiders. One may question where they got a billion dollars, you know, but we look at these Russian companies, you know, there’s a fair amount of taxation that goes on by the Russian government, and there’s probably another … call it less official means of taxation in the from of, you know, more nefarious activities occurring within the companies. However, the earnings we see are audited by legitimate companies and these earnings that we’re seeing today are already met of both forms of taxation, and they’re cheap on that basis. So as long as things don’t get worse in that regard, we can be pretty comfortable with these companies that we’re buying at these prices today.

Consuelo Mack: So it really is because of the prices? Because I mean, it would make me nervous as an investor to know that you are in basically a thugocracy, as someone told me, with Putin running Russia, and you know, heads of companies get thrown in jail at any given moment if they get too powerful. So for someone who’s most concerned about avoiding the permanent loss of capital, and you always say that your defense is more important than your offense …

Steven Romick: There’s no argument that this is a complex country with an authoritarian regime. There’s no argument there. However, again, we feel that price is the guide, and we argue we do play defense first. We think about it in terms of the whole portfolio, so it’s a defensive portfolio. If you’re not willing to lose a little money along the way in certain investments, you’re not going to make money either. So there’s no chance you’re going to go through life and not lose money. So if you size positions correctly, and we believe that our investments in Russia are sized appropriately. Not to say they won’t increase somewhat, but it’s never going to be the largest part of our portfolio for sure for some of the reasons you’ve mentioned, but we certainly are willing to accept some risk attached to that. And don’t forget, you can’t steal from something that’s insolvent, the country needs these companies to continue to spew off cash. Again, 25 percent of GDP, 50 percent of Russian government revenues, so you need these companies to continue to renew throw off cash flow to fund whatever the regime wants to do.

Consuelo Mack: One of the things that you and I have talked about in the past is that you look for companies that you call compounders, and these are companies that you know you’re definitely going to make money. The question is not if you’re going to make money, but it is how much money you’re going to make, and in five to ten years they’ll be worth a lot more than they were today. So what are your favorite compounders in the FPA Crescent portfolio right now?

Steven Romick: Well, one example of a compounder would be a company called Meggitt PLC. Meggitt is an aerospace supplier, and we actually like the aerospace industry. I mean, you’ll have growth in passenger traffic. You know, 3 to 6 percent over the next 10, 20 years. That’s a nice place to start from. Airline traffic is going to increase around the globe for a number of reasons, not the least of which is growth in emerging markets, growth in population, as well as growth and increase in wealth. More people will fly, more airports are built, you know, and it all feeds upon itself and you’re going to see a lot of that over the next ten, 20 years. So to find a company like a Meggitt, which is dominant in the wheel and brake business, and they have a number of other businesses, but the biggest portion of the profits comes from wheels and brakes. They have more than 50 percent share in the regional jet market as well as the business jet market, where in those two markets they are single source. So a company, an OE, an original equipment manufacturer, will go and contract with a Meggitt or somebody else, and hopefully Meggitt in our case since we own Meggitt, and will contract with a Meggitt, and Meggitt basically gives them the wheels and brakes for free, because they make all their money in the after market, and there’s huge margins on that. And these products get priced as the wheels wear out and parts break, and you know, they get price in this over time, you know, ahead of inflation. So it ends up being a terrific thing, and you’d have terrific confidence that you can get a vision for what the earnings will look like in the future.

Again, to your earlier point as we think about compounders, we can’t know exactly what they are, but this is a company that we felt was going to grow at a very healthy clip that generates a lot of free cash flow. We hope that management makes intelligent acquisitions and uses of that capital, which there’s no guarantee of that, and the risk out there for Meggitt would be how they spend their capital, because they’re an inquisitive company. They’ve done a reasonably good job historically, but the fact is the returns on capital for their core organization, you know, and for the business are very, very, very high, and that’s what we want them to focus on and buy shares back intelligently as prices permit. So as we think of the future as we look at Meggitt, we think that five to ten years from now this is going to be a better business than it is today, and as long as the multiples at least maintain we’ll do very well, and given the fact we bought a company at a discount to the market, there is some option out in the multiple. That’s not something we’re counting on.

Consuelo Mack: We always ask all of our guests at the end of the interview is if there were one investment we should all make in a long term diversified portfolio, and you can never recommend your own fund, what would it be?

Steven Romick: You know, it’s interesting today. I actually see today as being more opportunities in the private sector than there are in public. I mean, where there’s more inefficiency, relatively speaking, is in the private sector, which is why in our fund we also invest in certain illiquids, and we’re able to make certain real estate loans and get low … (Overlapping Voices)

Consuelo Mack: Real estate loans.

Steven Romick: First lien real estate loans. We partner with a AAA real estate investor to make first lien real estate loans. And we’re getting low teens, you know, IRRs … expected IRRs, I should say … on these loans, and we’re very excited about it, given the good loan to values that we have. And I think that for an individual investor, I think at this point in time, one needs to be wary.

Consuelo Mack: One of the things that you and I had talked about the last time you were was you were also investing in farmland, in private partnerships that had invested in farmland. So these are in liquid, they’re long term investments, they’re a very small part of your FPA Crescent portfolio, but that’s the kind of things that you are having to get involved in because there are so few other opportunities out there.

Steven Romick: Yes, but I would also say it’s more than that, because in the case of farmland, which we first invested in a number of years ago, and it’s not as inexpensive as it was.

Consuelo Mack: It’s definitely appreciated.

Steven Romick: So it certainly is work … it’s not just a question of so few opportunities out there, but we like the way that investment would behave in a number of different scenarios, not the least would be inflation, decline in fiat currencies, so we felt it made sense within the portfolio. But it wasn’t just because we couldn’t find investments elsewhere. Same thing with the real estate loans. I wouldn’t say that we wouldn’t own these real estate loans in a different environment where there was more opportunity, because we very well might, depending upon what was there, what was available elsewhere. Because these real estate loans, I mean, our goal is to provide equity rates of return to our clients, and to do so in the void of permanent capital along the way. And if you can go and get low teens IRRs, as we think we’re getting on these real estate loans, then why not? And we’ll take that all day long. And it’s not going to have the same kind of volatility as other investments might, won’t get the same market to market risk, you know, in the portfolio day to day, and we miss clip coupons for a few years.

Consuelo Mack: And last question: What would get you more interested in investing some of your cash?

Steven Romick: Again, it’s bottoms up, and we talked about a couple of themes. Aluminum was one. You know, Russia was an example that you brought up. And so it could be thematically driven, where we see areas of the world or asset classes or industry groups that fall out of favor or individual companies having a little stumble along the way.

Consuelo Mack: So Steven Romick, it’s always a pleasure to have you here on WealthTrack, so thanks very much for joining us.

Steven Romick: Thank you.

Consuelo Mack: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point: keep a stash of cash in your portfolio. Cash has become a dirty word in most investment circles because it yields close to nothing right now, but it has other redeeming virtues that make it a must have asset. Cash adds ballast to a portfolio in choppy markets. While other investments rise and fall, it provides stability and protection. It adds liquidity and opportunity. Cash can be put to use in a moments notice, especially to buy when others are selling. And it provides a psychological advantage: Fairholme Fund’s Bruce Berkowitz calls cash “financial valium.” It keeps him calm when others are panicking. Next week is the start of one of public television’s fund raising drives so WealthTrack might be pre-empted in some markets. We are therefore revisiting an interview with another Great Investor and Morningstar fund manager of the year, the Royce Funds’ Charlie Dreifus will explain why a small-cap manager is also investing in large cap stocks. Please go to our website to hear our extra interview with Steven Romick. Also visit our new WealthTrack women section. We will have updated financial advice specifically for women from our panel of award winning women financial advisors. In the meantime as you enjoy your Memorial Day holiday take a moment to remember all of the soldiers who sacrificed throughout our country’s history to make our precious freedoms possible. We owe them our undying gratitude. Have a lovely weekend and make the week ahead a profitable and a productive one.

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