Investment Strategies
We believe that determining the correct asset allocation for clients requires an understanding of personal investment goals and current economic conditions. This is one of the key concepts in financial planning.
Our current approach to allocating investments is influenced by the belief that we may be entering a long term period of uncertainly in the world economy and the equity markets. We feel the rate of growth that we have experienced over the past decades in real estate, consumption, and production is unlikely to continue. This could result in a long period of economic activity that is quite different from the past, thus requiring new investment strategies for future success.
We base this statement on five factors:
- Cheap energy is coming to an end. The world economic growth has been based on having an endless source of cheap energy.
- Global warming is now a fact altering many critical economic factors.
- The world is now over populated and becoming increasingly politically unstable due to globalization, and the increasing divide between the rich and poor countries.
- Natural resources such as water, soil, and timber, are being depleted at an ever increasing rate and ecosystems are becoming increasingly degraded.
- Lastly - and perhaps least important, although it will likely impact the immediate future – is the retirement of the baby boom generation starting in 2008.
Based on these factors we think it is important to focus on socially responsible investing with an emphasis on:
- Clean energy sources
- Conservation technologies
- Resource limited commodities
- Socially screened international companies
- Healthcare companies that will profit from an aging population
We also think it is important to take a more conservative approach to asset allocation than most Wall Street Firms would suggest by maintaining a large income sector in your portfolio. Within this sector we use innovative investment instruments such as Linked Index Notes to provide downside principal protection in a falling market.
Finally, for larger accounts we recommend putting 10% - 15% of your assets in Managed Futures. Studies have shown that investing a small portion of your assets in a portfolio of future contracts managed by a professional company, can help lower the volatility of your own portfolio. Managed Futures may also provide a hedge against a falling U.S. dollar.
By combining these various approaches to asset allocation, we believe it is possible to maintain good performance with low volatility, while investing according to our clients social values.
By Richard W. Torgerson, © 1999
Linked Index Notes offer the principal protection of a bond or CD (depending on the issuer) with the potential returns of the stock market. Like bonds they have a definite maturity date and the principal investment is guaranteed by the issuing financial institution (if they are a CD they are guaranteed by the U.S. government).
They differ from bonds in that instead of a periodic fixed interest rate paid to you, they give you one interest payment at maturity. The amount of that interest is based on the percentage growth of an underlying set of equities, such as a group of stocks (e.g. several Solar Companies), a basket of commodities (e.g. cooper, nickel and zinc), foreign currencies vs. the U.S. Dollar, and/or a stock index (e.g. S&P 500, Nikkei 225, etc). At maturity you'll earn a return comparable to that of the underlying equities if they increase in value, otherwise you get your money back.
Who Creates Them and How Do They Do It?
The Linked Index Notes available today are created by major financial institutions and brokerage firms. A portion of the proceeds are used to buy sophisticated futures and/or options contracts designed to insure the availability of cash to pay the interest on the note, no matter how large the interest payments grow. The remainder of the funds are used to purchase zero coupon bonds, to ensure payment of the principal. The repayment of principal and interest are backed by the full faith and credit of the issuing firm. When is the last time a financial institution guaranteed the return of your principal to you?
How Safe Are They?
The notes are as safe as the company who has issued them. Barclay’s Bank and Merrill Lynch, for example, currently have a double-A credit rating, meaning that Index Notes issued by these firms are creditworthy enough for most banks and insurance companies to be comfortable owning them. The creditworthiness of each note issuer should be included in the analysis of how attractive each would be to buy.
What Can Index Linked Notes Do For Me?
By combining the return potential of stock investments and the principal protection of bond investments, you can reduce your market risk without a corresponding reduction in return potential.
An Example
On Jan. 1st 2005 you buy 1000 new index notes at $10 per note, costing you $10,000. This note pays one interest payment when it matures on Jan. 1, 2010 (5 years away) of an amount equal to the percentage rise in the value of a “basket” of five solar companies from a starting point set on Jan 1, 2005. The percentage rise of a basket of stocks is typically calculated as the average of the rise in the individual stocks in the basket. So, for example, if the five year performance of our solar company stocks were 45%, 37%, 52%, 30% and 14%, then the percentage rise in the value of the “basket” would be 35.6%
Here's what you get under two different scenarios:
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Scenario #1: Market goes up.
Here the basket of solar companies has done extremely well over five years, and the percentage rise in the value of the basket has gone up 100%. So in this case your investment has matched the return of the solar companies, while owning a bond.
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You get at maturity |
| Principal ($10 X 1,000 notes): |
$10,000 |
| Interest Paid (100% X principal): |
$10,000 |
| Total Returned: |
$20,000 |
| 5 Yr Return for Index Note: |
100% |
| (or 14.9% per year) |
|
| Ave. Return of 5 solar stocks: |
100% |
| (or 14.9% per year) |
|
|
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Scenario #2: Market goes down
Here the solar market has gone through rotten times. During this time the return on the basket of solar companies has gone down 50%. A 0% return means you preserved your principal while the underlying stocks got chopped in half.
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| |
You get at maturity |
| Principal ($10 X 1,000 notes): |
$10,000
|
| Interest Paid (100% X principal): |
$0 |
| Total Returned: |
$10,000 |
| 5 Yr Return for Index Note: |
0% |
| (or 0% per year) |
|
| Ave. Return of 5 solar stocks: |
-50% |
| (or -12.9% per year) |
|
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So in other words if the solar market keeps going up, you stay with the market with comparable returns. But if the market decides to head 'south' you're assured by written guarantee of the issuing Financial Institution (or FDIC if a CD) to get the note principal back, mitigating the loss that other market investors would suffer. This is what we mean when we say that Index Linked Notes offer high return potential with lower risks.
One of the most useful but least understood investment opportunities are Managed Futures (referred to as MF for brevity). For many people the word "futures", like "options", immediately creates an image of risk and a reaction of fear. The fact is, studies show that if a portfolio of stocks and bonds is adjusted with a 10% - 15% allocation to MF the risk declines and the performance improves.
Lowering Risk - Increasing Performance
Investing in Managed Futures simply means allocating a small portion of your portfolio into future contracts managed by a professional company.
The reason Managed Futures reduce risk when added to a stock and bond portfolio is that there is little to no correlation (sometimes negative correlation) between MF and stocks or bonds. This means whether stocks are up or down does not coincide with whether MF are up or down. If the stock market has only one down year in a decade, the chances that will coincide with a down year in MF is relatively small.
The Barclay CTA Index, which averages some 300 MF programs, is a good measure of how these investments have performed relative to stocks and bonds. From 1987 to 1996, the stock market (S&P 500) was up 15.3% per year, while the Barclay CTA Index was up 12.8% per year. For the same period, bonds came in at 8.4% and international stocks at 4.2% per year.
How They Work
Futures are historically associated with agriculture. When a farmer goes to a bank for a loan to plant his or her crop, the bank has the danger of a sharp drop in the price of the farmers product, the commodity (corn, for example), and thus that danger that the farmer will be unable to pay back the loan. What the bank often does is ask the farmer to sell his or her crop now in the “future.” The farmer sells his or her crop at a set price to a "speculator". Obviously, this is like buying insurance and the person helping the farmer is calculating a profit on the transaction – the cost of the insurance.
A far more common example of this role today is currency hedging. When a company begins to do business in another country they have to consider the risk of currency movements that may turn a profitable business into a losing proposition. So the company accepts paying insurance by using futures to protect their industry. The MF professionals are the ones assuming risk, but at a price. Over time, especially when there are clear trends in place, this can be a lucrative business. In any case, it plays a positive economic role that is often misunderstood. This is no gambling or making money without producing anything as is often the image people have. It makes it possible for large amounts of capital to be invested and productive facilities created.
Futures trading has grown tenfold since 1980 and now involves trillions of dollars. Future exchanges exist in 30 countries. Financial instruments, like currencies and bonds, now dominate over actual physical commodities. Trading goes on 24 hours a day.
Managed Futures Are Not for Everyone
Like all asset classes, MF may not be appropriate for you. Some CPO’s are only for accredited investors (investors with a net worth of over one million). Other MF programs exist for small investors. It is our belief at the Camejo Group that many of our clients would benefit by allocating a portion of their portfolio to a MF program. It may be best to start with a 5% target allocation and gradually add to this position as your portfolio grows.
To learn more about MF and to find out if they would be appropriate for you call an investment advisor at the Camejo Group.
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