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Long-term approach fights to stay afloat in uncertain times

Rochester Business Journal
September 28, 2012

See correction below:

With unemployment hovering above 8 percent, an unpopular Congress seemingly incapable of passing legislation to address the country's financial problems, global debt troubles and the upcoming presidential election, the effectiveness of long-term investing is under attack.

Andrew Lo, a professor at the Sloan School of Management at Massachusetts Institute of Technology, is among the most skeptical. He has proposed an adaptive market approach in which conventional philosophies of financial economics are mixed with behavioral models.

Still, many money managers remain true to long-term, or buy-and-hold, investment strategies.

"Buy-and-hold is exactly what we're all about," says James Gould, president of Alesco Advisors LLC in Pittsford. "We are very strategic in our investment focus and very much embrace long-term thinking, not trying to get overly technical when it comes to managing portfolios."

Some have changed their tune, given the volatility of the past decade and more, starting with the tech bubble at the turn of the century. Others have never entered the buy-and-hold camp.

"Our firm has never been a buy-and-hold firm, ever," says Edward Shill II, principal and chief investment officer at QCI Asset Management Inc. in Pittsford.

"I've been doing this for almost 30 years. I don't know if the retail investor should take a different program than buy- and-hold, but if you have indicators and beacons to look at when the horizon is foggy and can kind of scale in and scale out, that's a better program."

For others, adherence to long-term investing depends on the length of the term.

"It depends on what you mean by buy- and-hold," says Craig Cairns, president and chairman of Howe and Rusling Inc. in Rochester. "If you mean buy a stock and hold it for 20 years, Kodak is a good example of why that might not work anymore."

Making it work

Buy-and-hold has worked for Alesco Advisors since its founding 12 years ago, chief investment officer Todd Green says.

"We're still applying our same strategy," he says. "It's worked very well for our clients.

"We're concerned about the known risks that are out there, specifically what's going on overseas. We have had an underweight in international investments versus the overall industry, specifically in the overseas stock markets. In the overseas bond markets, we have zero exposure, not wanting to take on the risks of international debt."

Domestically, Republicans and Democrats continue to bicker about long-term debt and the economy. Agreements on budget and tax issues are required by year-end to avoid going over the "fiscal cliff"-recession caused by higher taxes and lower government spending.

The Federal Reserve, meanwhile, launched a third round of quantitative easing two weeks ago in which it plans to buy as much as $40 billion in mortgage-backed securities each month.

"Because the Federal Reserve-and the federal government as well-has pumped so much stimulus into the economy, there is a risk of inflation," Green says. "We have diversified our clients' portfolios to make sure that if we do get that inflation, they're well-protected."

Shill, for one, is not happy about the latest quantitative easing.

"I kind of view it as pouring gasoline on wet timbers," he says. "More gasoline on wet timbers, without a spark, doesn't get you fire.

"There's a huge disconnect between where rates are at this point in time. The 10-year is at 1.8 percent. Both current and expected inflation are above that number. I think this is going to end badly from a bond market perspective. I think rates could move meaningfully higher over the next three years."

QCI has been scaling back investments lately and favoring more cash, given the market's uncertainty.

"I like to say we're putting a little meat in the freezer," Shill says.

He says the equity market has gotten ahead of itself, with the Standard & Poor's 500-stock index up 25 percent from a year ago.

"I don't care who they pick for president," he says. "They could bring Ron Reagan back and I think it'd go very poorly.

"I think 2013 is going to be a tough sled. The headwinds could intensify, whether it's the fiscal cliff or historically the first year of a presidential cycle has a pretty tough sled to it. I believe the Fed is shooting blanks at this point."

Howe and Rusling manages a growth-oriented equity portfolio and an income-oriented equity portfolio. Both are geared toward buying and holding rather than active trading, Cairns says.

"Our turnover the past five years, depending on the year, has been between 30 percent and 50 percent," he says of the growth portfolio. "That equates to a holding period of between two and three years. Our equity income portfolio has been much lower. We consider that to be buy-and-hold."

The average turnover in equities for all mutual fund assets since 1974 is in the range of 60 percent, Cairns says. The Howe and Rusling average in 2011 was 52 percent, he says.

"The market is extremely volatile," Cairns says. "I think you have to be more willing to pull the plug on a stock that is not working out, if your investment thesis is such. And if your stock has done really well and you feel like it has reached fair market value, you should be willing to sell it.

"Bad news punishes stocks severely in this type of market, and good news rewards stocks," he adds. "You may have to be more nimble and quicker to make a decision. But that doesn't equate to much higher turnover, we don't think."

Reasons for strategy

There are at least four reasons why buy-and-hold is superior to trying to time the market, Green says. The first one is simple mathematics.

"We know we have to time ourselves into the market," Green says. "We also have to time ourselves coming out. If it's 50 percent probability for each, we know that the probably of getting that whole trade right is 25 percent.

"Over time, that is a losing proposition. If you go to Vegas and play those odds, you're going to lose."

Secondly, superior decision-making is relatively rare in timing the market, Green says.

"There's no evidence that anybody has a crystal ball to predict the future," he says. "Academic studies and empirical evidence have shown that it's more often due to luck than skill. Again, if you roll the dice you're going to get it right every once in awhile, but that doesn't mean you know what you're doing."

Thirdly, buy-and-hold lowers trading costs, controls risks and has fewer consequences related to income taxes, Green says.

"The fourth reason is we're human beings," he says. "Our emotions get in the way of knowing what's best to do from an investment standpoint.

"When we feel our worst, that's when we should be putting money into the market. When we feel very euphoric, we should be pulling money out."

But investors generally do the opposite.

"They want to invest when they feel good, and they want to get out of the market when they feel bad," Green says. "Our human emotions get in the way of any chance we have of trying to time the market."

The problem with the buy-and-hold approach, Shill counters, is its tendency to become buy-and-forget.

"There are only three zones in the stock market," he says. "The market is either overbought, like it was in 1999 or 2007, or it's oversold, like it was in 2002 or 2009, or it's like it is most of the time.

"In our modeling, if the market is overbought, you can scale into that, add on some airbags. Then when the market does sell off you can pull those airbags off when the market gets oversold. You can do an asset allocation dance, if you will."

QCI was an aggressive buyer in December 2008 and March 2009, at the beginning of the recession, Shill says.

"Now we're scaling it back," he says. "We're not going to zero percent equities, and we have names that we're buying and names that we like. But net-net, if I'm running an IRA rollover and you were 60 percent in equities in January, we have you down somewhere between 45 percent and 50 percent in equities."

Shill notes an upward sloping demand curve for stocks.

"If they raise the price of milk to $20 a gallon, you're probably going to feed your family less milk," he says. "With the stock market, that's not the case."

Studying options

Buy-and-hold can result in significantly lower returns, Shill says.

"The opposite of that is all these market-timing charts," he says. "Over the last 10 years, if you miss the best 10 months out of the market, you ended up with a Treasury bill rate of return. Your ability to buy when the market is ugly and to sell when everything is good is kind of tough to do."

The complacency in the current market pales in comparison to the recessions from 1999 to 2003 and since the 2008 recession, Shill says.

"No way are we close to the complacency we had in 1999," he says, "and that was a tough period for us because we were selling technology stocks starting in, like, 1997.

"The last nine months of 1999, right before the peak, the Nasdaq went up 85 percent in nine months. If you didn't own technology stocks, everybody thought you were an idiot."

Shill does not expect a 50 percent bear market over the next 12 months.

"I do not think this is a replica of the 2007-08 time frame, or anywhere close to the 1998-99 time frame," he says. "But I do feel like you could have an increase in volatility."

The market may trend downward over the next nine months, Shill says, based on the belief that it is ahead of itself now, and because the economy is unsettled it could be even more slippery in 2013.

"Could we have a 15 percent bear market?" he says. "All day, and I want to play that. I want to be able to have some dry powder sitting on the sidelines, so if that happens I can step back in and buy some of these good companies."

Cairns agrees: "There are good options in any type of market. There may not be as many, and that is probably true right now because there's a lot to worry about. ... But that doesn't mean there aren't opportunities and that there aren't stocks that you can continue to hold and ultimately do well on. But there are fewer."

9/28/12 (c) 2012 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email
service@rbj.net. This correction appeared in the Oct. 5, 2012 issue:An article in the Sept. 28 Special Report misnamed QCI Asset Management Inc.


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