2010 Report to Clients*
About this report…
In this space last year we made a pledge to you, our clients, that we
would be here for you in the future. In 2010 we took effective steps to
make this pledge a reality.
For a little history, you helped Sam start the firm in 1994 as a
FeeOnly® Investment Adviser. This created the platform that allows us to
charge you for our advice as opposed to receiving commissions for
investment “products” you “buy” (or are sold). For Tom and me, the
assets-under-management (AUM) model is a great way to do business. We
don’t lose sleep worrying about what we can “sell” you next month to
generate some commission income. When we come to work in the morning, we
spend our time (and other resources) looking for investments that fit
your objectives and needs.
This doesn’t mean we always sleep well! The AUM model puts us
squarely on your side of the table, both short term and long term. We
remember 2008-2009; in a word, it was horrible. Of course, it is not
possible to prove that charging for assets under management versus
commissions delivers better investment returns over the years. Our hope
is that any value we can add with our judgment, combined with low
transaction costs and minimum turnover, will generate pleasing
investment returns over time. In any event, your side is the only side
of the table we want to work on.
Back to the present, there is a limit to how much fun one can have.
At some point, Sam (the old-timer) will have to stop, or slow down, even
if the only reason is the law of large numbers. As with any small firm,
such an eventuality can be disruptive. One way to address this
uncertainty would be to sell the business, and we investigated this
option with at least two interested parties. In both instances, we soon
realized that the firm would not be operated in the same fashion if it
were sold. Whereas Tom and I enjoy operating with a small number of
clients and working hard to invest your money according to what is right
for each of you, any buyer of the business would operate on a larger
scale. You would receive less individual attention and more
one-size-fits-all investment “solutions.”
Tom and I both believe there is value in our services and how they
are delivered. So we rejected the possibility of selling in favor of a
solution we hope will preserve the firm’s operating model. Namely,
ownership was transferred to Tom. We spent the first six months of 2010
negotiating and discussing with each other what each of us wanted and
what was the best way to serve your interests. When we were able to
identify these precepts, we hired an attorney to “make it legal.” By the
middle of September, you fulfilled your role in the process by signing
and returning documents required by the regulatory authorities. (Once
again, it comes to our attention that we exist because of our wonderful
clients. Thank you again.)
As a result of this transition, when the time does come for Sam to
stop or slow down, for whatever reason, it should be a non-event for you
and the firm. Meanwhile, he enjoys a robust employment contract which
duties include writing this report. At the risk of being repetitive, we
both think the transition steps we took in 2010—with your help—will
enable the firm to continue giving investment advice we believe in.
For more detail about Sam’s employment contract, one of the firm’s
goals is to improve our communication initiatives, especially with
regard to the internet and our website. And in a continuing response to
the crash of 2008-2009, which tested investors’ investment strategies,
we are beginning a process to review your individual Investment
Strategies. Do they continue to match the risk you are willing to assume
for the investment returns you seek and need? (See LEVEL I, Long-Term Interest Rates, Outlook and Portfolio Construction.)
Sam is looking forward to being involved in both of these endeavors;
additionally, he remains the firm’s Chief Compliance Officer and has
portfolio management and research responsibilities.
INSIDE THE MARKETS
At H.S. Dreher Capital Management, LLC we use four broad
investment classifications to help us diversify your portfolios. We
believe investments in each of these categories are necessary to receive
what we call a “Complete Investment Experience.” Within these
four broad categories, it is possible to identify an infinite number of
sub-categories to provide even more diversification and exposure to
various investment choices.
Specifically, we have identified seven investment sub-categories
that we believe are necessary to construct a properly diversified
investment portfolio. Three of these are income oriented; four are
growth oriented. We call these seven sub-categories the “Essential
Elements for an Effective, Diversified Allocation Strategy.” The amount
of your funds allocated to each of these markets depends on your
individual Investment Strategies and the opportunities we think we
discover in each market.
For the most part, these seven investment categories added year
number two to their impressive rallies begun after the 2008-2009
wipeout. Thus, on the surface the most important characteristic of 2010
was total participation on the upside. Delving a little deeper into
these results reveals some—possibly important—observations for
One, the annual returns were more varied in 2010.
The REIT, mid-cap and small-cap categories continued to exhibit 20%-plus
returns, outpacing utility, foreign and large-cap stocks. In 2009,
large-cap equities did a better job of keeping pace.
Two, even though bonds were last for two years in a row, they have the best return for the most recent three-year period (that includes the 2008 crash), turning $1.00 into $1.18.
Three, despite the financial press’s love affair
with investing abroad, it produced the worst record of our seven
elements over the past three years. One dollar has declined to only
$0.81, as the segment experienced one of the worst declines in 2008, and
its recovery lost its trajectory in 2010.
Four, average returns continue to deceive. As
reported by mutual funds, mid-cap stocks averaged a 9.3 % return for the
past three years; bonds averaged only 5.8%. (Which would you rather own
for the period?) In fact, $1.00 invested in bonds turned into $1.18
versus only $1.11 for mid-caps, once again demonstrating the importance
of using compound annual rates to accurately
measure investment returns. Looking at average returns only, one might
conclude that five of our seven elements have recouped their 2008-2009
losses, since they exhibit positive average returns. As the
value-of-$1.00 column shows, however, almost the opposite is true: only
three out of the seven categories have managed to hold onto, or grow,
the value of the $1.00 with which they started.
Are these observations trends that investors should follow, or do
they represent opportunities for investors to take a contrary investment
position? In the pages that follow, we peel back the onion to examine
the conditions of the markets as we find them. Below, we have ranked the
seven elements by their annual returns over the past ten years. The
only thing we know for certain about how the next decade will unfold is
that it will contain surprises!
*Complete reports available to clients and subscribers in Client Area.