2015 Performance Report and Investment Outlook1


If MCS clients were one large portfolio including their cash, the 2014 return was 8.99%. Individual client returns ranged between 14.71% and 3.72%. The client with the lowest return was negatively impacted by exposure to European stocks and had fewer bonds overall. The client with the highest returns had a significant portion of zero coupon bonds, which post large gains when interest rates fall.

Auxier sub-portfolios, on average, gained 5.36%. The Auxier results are included in the total client results above. Auxier 2014 results have been a drag on client returns; in 2013 it was the opposite. Auxier results compared to the S&P 500 have lagged significantly this year partly due to his European stock exposure. For active stock managers, it was the worst year since 1997; 84% underperformed the S&P 500 index. The average hedge fund manager was up 2%.

For comparison purposes, the S&P 500 Total Return Stock index gained 13.69% and the Barclays Aggregate Bond Index gained 5.96% for the period. MCS client portfolios had a much better year than I expected. In 2013 and 2014, I had prepared for more volatility by building cash to await buying opportunities as bond yields increased…


The ‘smart money’ got 2014 very wrong.

To wit: at the beginning of 2014 bond losses were anticipated for the year. Wall Street economists expected the yield on the 10 year US Treasury bond would end 2014 at 3.52%. Instead the yield ended the year at 2.17%, producing a total return of 9.28%. The consensus expectation for oil was $96.65 / barrel. Instead, it ended the year at $53.27/barrel. On average (1900-2013) the stock market has declined 10% or more about once a year; last occurrence, October 2011.

The case for higher US rates due to improving US economic growth and employment is being trumped by faltering growth and deflationary risks in Europe. Interest rates in Europe fell to unprecedented lows and the Euro weakened substantially against the US dollar. The strong US dollar and higher (albeit historically low) US interest rates compared to European countries and Japan confounded the expectations of market professionals. In 2014, it seems that every week some pundit was warning about how poorly bonds would perform when rates soon went up.

Continuing into January 2015; the Swiss National Bank shocked the markets by removing its three year old cap on the Swiss Franc’s value against the Euro. The result was billions in losses overnight; one example: $830 million, Everest Capital Global Fund is closing after losing almost all its money.


What does this tell us?

  • Professional investors, including me, do not fully understand the dynamics unleashed by the global recession, uneven global recovery and near zero interest rates. Risk abounds in the form of unanticipated changes in how investors viewed the world vs. how it is actually turning out.
  • A globally diversified portfolio did not perform particularly we ll because the best results were confined to the largest US stocks and high quality bonds.
  • Investment success may be due to unforeseen circumstances rather than insight.

Clients: Emotional Responses to MCS Strategy in the Current Environment

Several clients have expressed concern about the growing cash balances in their portfolios.

  • Some are concerned that ‘I’m not doing anything’ because their cash balance appears unchanged or is growing. Looking at monthly cash balances can be misleading about the level of account activity. Bonds are maturing and those bonds have been replaced with new purchases.
  • Some fret because they feel cash is ‘costing’ them since they pay a management fee on it and cash earns little to no interest. “My money’s not working!!”
  • Others have called to thank me for the good job I did last year; based on how their portfolio went up in value.

I have struggled with the best way to respond to client concerns about cash.

Perhaps I should start with the philosophical, move to the practical and finally to the questions you can ask yourself if you feel there is too much cash in your portfolio.


The Philosophical

The MCS tagline is ‘Managing Risk to Increase Wealth’.

  • Avoiding losses and big mistakes are critical to keeping your wealth intact
  • Managing risk involves managing emotions and related thoughts
  • Investing only when there is a sufficient understanding of the downside
  • Having the discipline to wait; the markets do not care about what you feel you ‘need’ and when
  • Take only the amount of risk necessary to achieve your goal ‐ high probability of success trumps big possibilities attached to big risks

The MCS mission statement is;
‘Transform money from a source of worry to a resource for fulfillment’

The role of MCS is to successfully invest your money while offering e xpertise and some wisdom to keep you on track. We endeavor to create a reasonable degree of certainty about what your money can earn. We may also encourage you to spend when your ‘money worry voice’ is stuck deeply in the past and won’t acknowledge that you have succeeded in saving enough.

My strategy is relatively simple yet unconventional.

By building a portfolio that produces an ongoing, reliable income stream, continual price appreciation is unnecessary to create financial security. In other words, if the portfolio produces 5% and you can comfortably live on that, you need not worry about year to year changes in the portfolio’s value. It is like owning a profitable, stable business that earns money in good times and bad. What if you don’t need the income right now? No problem. Income earned is reinvested to create more income.

For nearly 30 years, bonds have been the foundation of my strategy. For 30 years I’ve been reading what a bad idea owning bonds is… all they way to financial independence. Today, I agree that most (not all) bonds are unattractive. That’s why cash is building up. The portfolio strategy is working as it should.

I have not given up on implementing the strategy that has served us so well. Today, pickings are thin. Every asset has benefited from low interest rates and is thus trading at high prices. I believe that th is will change but I don’t know when. To succeed today, you must be patient and wait for something to break in order to create attractive prices / yields. Right now energy related securities are breaking!


The Practical

As an MCS client, you have given me written instruction to do my best to limit losses in all or the majority of your portfolios to 12-15% in any one year. Stock markets can decline over 35% in a single year. Cash is necessary to control the risk that you have instructed me to manage.

Every investment uses interest rates to help determine its price. All else being equal, low interest rates increase an asset’s price and high interest rates decrease it.

Reducing cash in your portfolio changes the portfolio’s risk.

Money related emotions are fickle. While it’s important to acknowledge how a client feels now, I must be mindful of a bigger picture and how quickly those feelings can change.

I know I can be wrong. I prefer to err on the side of not making what is perceived to be ‘enough’ rather than err by losing ‘too much’. Cash builds until I find an investment opportunity that is consistent with my philosophy.


Figure 1
Perception of holding a ‘lot of cash’

MCS | Quarterly Report | January 2015 | Figure 1

What I am Doing

I may further increase cash across client portfolios this year by taking profits on selected stock and bond holdings. I have never invested with the concern that proceeds from a sale had to be put back to work immediately. Sell and buy decisions are independent of one another, if they just happen to coincide, great.

In some cases, I have moved cash out of our management to reduce the stress the client is feeling. Keep in mind that removing too much cash may present a conflicting instruction to me. What is more important, risk management or saving a comparatively small amount of money?

Clients with the largest cash balances (typically over 20% as a percentage of their portfolio) are first in line when allocating limited purchases.

I have brokers contacting me every day to show me their ‘good investments’. What they hear most often is “No thanks, but keep showing.”


Your Options

Feeling anxious about cash? Conduct a personal check-in:

  • Do you have more money now than you’ve ever had in your life?
  • Is having too much cash really a problem? Or is it an attribute of disciplined investing?
  • Is something making you envious?
  • Let us know your concerns and we’ll work through them.

Soft Close to New Clients

Because we are very challenged trying to put existing client money to work, we are not taking new clients with only or mostly cash to invest. Our first obligation is to find solid investments for existing clients. We don’t want new client’s money reducing investment allocations to clients who have trusted us for years.


Good News

Buying opportunities occur when bad things happen to an asset class, and bad things have happened to energy and commodity related securities this year. I am spending a lot of time analyzing energy related bonds, stocks and master limited partnerships. Fifteen percent of the high yield debt market is energy related. The price declines of energy company securities have varied from small gains to losses of 90% or more in the past six months.


1MCS Family Wealth Advisors (MCS) client returns are dollar-weighted, net of investment management fees unless stated otherwise, include reinvestment of dividends and capital gains and represent all clients with fully discretionary accounts under management from 12/31/2013 to 12/31/2014. These accounts represented 96% of MCS’s assets under management as of 12/31/2014 and were invested primarily in US stocks and bonds (19% of client assets on 12/31/2014 were invested in tax-exempt municipal bonds). The Stock Index values are based on the S&P 500 Total Return Index, which measures the large-capitalization US equity market. The Bond Index values are based on the Barclays Capital US Aggregate Bond Index, which measures the US investment-grade bond market. Index values are for comparison purposes only. The report is for information purposes only and does not consider the specific investment objective, financial situation, or particular needs of any recipient, nor is it to be construed as an offer to sell or solicit investment management or any other services. Past performance is not indicative of future results.