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Election Year Volatility: Managing the Risk of Market Decline
08/11/2019
Election Year Volatility: Managing the Risk of Market Decline
Date: August 9, 2019 Attendee and Guest: Kelly Coughlin, CEO, EveryDay CPA – Kirk Chisholm, President – Innovative Wealth & InnovativeAdvisory Group Good morning everybody, this is Kelly Coughlin, CEO and CPA of EveryDay CPA, providing star services of strategy, tax, accounting and risk management services to businesses and business owners. Today I am going to interview the CEO of a very interesting wealth management firm. He specializes in two primary areas, using alternative investments like real estate to complement a traditional portfolio of stocks, bonds, and cash, and the second is creating a traditional portfolio of stocks, bonds, and cash, but complementing that portfolio with what we call inverse correlated assets. An inverse correlation, also known as negative correlation, is a contrary relationship between two variables, so they move in opposite directions. Or, to put it simply, when one bucket of assets goes up in value the other doesn’t go up or doesn’t go down. And when taken in combination, they together produce a good and reasonable rate of return. The popularity of this type of strategy has been growing substantially in the past four or five years and used by institutional investors for many, many years. But on T.V. you could see ads like crash proof retirement, which at their core simply used insurance annuities to offload the risk to insurance companies. But then you will also see guys like Ken Fisher saying, Never ever hold an annuity. It’s no wonder the people are confused, but in steps, my guess today, Kirk Chisholm, President of Innovative Wealth and Innovative Advisory Group. Kirk, how are you today? Kirk: I am doing great Kelly. I am doing awesome on this wonderful Sunday morning. Kelly: Great. And we already discussed, your kids are going to the water park? Kirk: Yes, yeah. Kelly: I have been to Kirk’s swimming club in the Boston area and - he has to pay a membership for that, and now his kids want to go out and spend another 50 bucks today, right? Kirk: Fifty bucks, Kelly, you don’t live in the Boston area, do you? That would be nice if it was only 50. The cost of happy three kids. Kelly: Kirk has a lovely wife that I have met, and I am sure there is, “Can’t we just go to the club, and it is right around the street”, and you lose that argument, right? Kirk: Yeah, every single time. Kelly: Great. Well, I have known Kirk for many years, folks, and his firm. And in fact, we have liked each other so much we decided to start working together. You might ask, why would an accounting firm do work with a wealth management firm? Sometimes people pit the two as arch enemies. Well, Kirk and I certainly are not. But here is how it fits into my company, EveryDay CPA, we do four primary things here, we call it our Star services, S T A R, Strategy, namely business strategy, Tax, Accounting and Risk Management. And this work with Kirk and Innovate Wealth is the key element of the R component, the risk component of the STAR system. And the reason I am doing this podcast now, today, at this moment is because it is especially important. There are two things going on. Number one, we are at some point in the continuum of the Trump Rally and two, we have a presidential election coming up next year. First, the Trump Rally. The market is up about 37% since Trump’s election. Now, note that at this point in Obama’s presidency, that is, at this point in the number of days of his presidency the market was up 52%. And ultimately, by the time he was out of office the market was up 147%. Now, we all know the reason those numbers are so high for Obama. By the time Bush, number two left office the market had lost 26%. So, he was at the very bottom of the market trough that he was able to creep or wade out of. And of course, Bush suffered such poor performance because 911 occurred shortly after his election, we had wars in Afghanistan and Iraq. So, anytime you have significant increases in the market, you also have an increased perception of risk that the market would give back some of those increases. So, today, up 37%, some of the fears justified, some of it is manufactured by annuity and insurance salespeople trying to use fear as a motivator to sell insurance products. These are the ads you see on T.V. and Kirk and I, he doesn’t know this yet, but we are going to have another podcast in a couple of weeks where we are going to talk about these Crash Proof Retirement Solutions. Because I will go on record right now, that will be the next shoe to drop in the investment world. All of this nonsense that has been peddled on Crash Proof, using annuities etcetera, shoe is going to drop. And the second factor that’s occurring here is the presidential election. There is no doubt in my mind that business owners, across the board, are fearful and nervous that if the Trump culture of reduced regulation, reduced taxes, pro-business mission and vision for America came to a screeching halt, during election, that nervousness and perception of risk would increase dramatically by business owners. And nervousness means business slowdown in capital investments, slowdown in new hires, slowdown in new product innovation, and this means decline in markets. Because the market is always about three-quarters forward-looking. Now, would this perception of increased risk in the change in leadership at the White House be justified or not? It’s a whole lot of questions, I personally think it is because I don’t see any of Trump's competitors being pro-business. In fact, I see nothing but anti-business sentiment. So, Kirk, that’s the background into which I am going to launch our discussion today. Kirk Chisholm, President of Innovative Wealth Management and Innovative Advisory Group, I gave you a lot to think about in that intro, and here is where I would like to start out. You have been doing this risk-managed portfolio stuff for many, many years, why does your strategy work? Does it work, and what does the portfolio look like when it does work? What does it look like when it shines, that is, when the general markets are declining? Kirk: Yeah, I mean, those are some great questions, Kelly, and I want to start by putting a little background for my history because I think that will be helpful. So, when I started in the industry back in ’99, December of ‘99, which of course, was probably the worst time to start, right? When you get off two decades of a bull market and then just started going through recession right away, so I learned risk management really quickly. You know, when I everyone else was thinking the market was going to keep going up and I didn’t have that because I started with pretty much the market going down. So, I learned real quick on how to manage money and how to manage risk in that kind of condition. For me, that’s why risk management has always been the top priority. It is rule number one, don’t lose money, and I paraphrased Warren Buffet there. So, we sailed through 2008 pretty easily, unscathed, because we had some understanding of what was going on, and since then we have built additional strategies to manage it even better. One of the things that I think people in the industry get caught up on is, they come with a strategy and they feel like, this is it, I am going to do this and this is going to solve all my problems, it’s the best strategy I have ever seen, and it will never change. The problem is, the market changes all the time. Every day, every second of the day it changes, and the more computerization that comes into the market the more rapidly that’s going to change. So, if you don’t have the agility, if you don’t have the ability to change on a dime with your strategy then you are going to get run over. I think this is one of the biggest challenges that we see, because when I got into the industry, you talked about, earlier, Kelly, with inverse correlation or negative correlation, one of the things I found was, initially, you could diversify properly and it would work, and generally speaking, you know, when the markets go up the diversified portfolio works as intended, typically. The market goes up about 66% of the time, when the market is going up diversified strategies work. In 2008, in that period, it stopped working. It’s fascinating, because we did some research way back, to dig into this, and what we found was, if you look to 2008, almost every single asset class except for cash and gold, went down. When you study and say, how is that even possible? So we did some digging and what we found was the net result was effectively that the institutions were causing a correlation, because all the big money was flooding into the market and making the same changes at the same time so it caused, effectively, this correlation of assets. So it became really challenging to create a diversified portfolio to reduce risks. You used to be able to invest in things like timberland and manage futures and hedge funds. That used to allow you to diversify properly and get inverse correlations. The problem is because everyone was investing in the same thing it was no longer non-correlated, it became correlated. Many people thought that they were diversifying and reducing the risk when essentially they weren’t. And they didn’t realize it because they were just accepting this norm as given by just saying, oh, this is the way things always are, they will always be this way. And it’s not, things change all the time, and if you are not assessing your assumptions, at any given time, then you are going to get run over in this market because things change so rapidly. So, that’s kind of how I look at risk management. That’s my background on it, why I look at things the way I do, which is a really important context, I think, of this conversation. Kelly: I gave a talk in London about one year before the Madoff Hedge Fund nightmare. I think that was in 2007, I was CEO of a financial technology investment firm. And the title of my talk was Hedge Fund Needs TLC, Transparency, Liquidity, and Custody. And I’m not bragging here, but - I guess I kind of am - that talk foreshadowed. I predicted this, it foreshadowed the issue that was highlighted by Madoff, specifically, and Hedge Funds in general. I think you would agree that Transparency, Liquidity and the issue with Custody were core and critical to the problems Madoff scandal highlighted. Do you agree with that? Kirk: Yeah, I do. You weren’t alone in your kind of assessment, I mean, our very own Perry Mecarpolis who was kind of one to find Bernie Madoff. He wasn’t the only one, there were more, but no one listened because when times are going well no one wants to pay attention to that stuff. They are not worried about it, only when times get bad that people worry. Well it’s too late, right? You have to, like you did, like you talked about it before the problem, and that’s you need to have those kind of resources because when times go bad it’s too late, everyone else is running to the door and it’s a lot harder to get out. Kelly: Yeah, this was at a Hedge Fund conference and it was like nobody wanted to talk to me at the cocktail hour after I said this. It’s like, okay guys, I’m sorry, I didn’t want to ruin the punch bowl but transparency and liquidity and custody, it’s just I want to clarify so listeners know why those are critical, because it’s still true now, more than ever, investor on the transparency side. Investors need to see the underlying assets in the portfolio, and that’s why I don’t like annuities, you can’t see anything. And then number two, investors need to be able to convert those assets that they do see for whatever reason, if they don’t like what they see, they need to be able to convert them to cash or another asset. That’s the liquidity portion. That’s another reason why I don’t like annuities. And then the third is custody. Ultimately, if you see something and you don’t like it you want to be able to access it, and if you have got some custodian that is nonexistent like we had with Madoff where he was just fabricating third party custody, you are going to have a problem. The reason I put custody at the end is because I like the TLC thing but custody in my mind is kind of at the top of the list because you need to be able to see the assets at a qualified bank or broker, not in the file cabinet of some Hedge fund manager that’s acting as custody. I am assuming you are going to agree with all that stuff. I know you do because you operate your company with TLC. Tell me, how would you score you and your portfolio strategy in the TLC paradigm there? Kirk: Yeah, and you raise a great point, Kelly, because I think that each one of those components has an issue attributed to it, in the markets in general and some of that field that we can kind of touch on here. But, you know, with my portfolio that’s exactly what we designed it around, transparency, liquidity. Possessions we have, have to be liquid because if something happens and you need to get out, you need to get out right away. Actually, it should be on custody first because that actually will start us off. So, we don’t custody assets, we custody at one of the bigger custodians which is TD Ameritrade. A firm like ours, we don’t want custody. I don’t want that liability. I would rather find a top-notch firm that does it really, really well and use them, and for us, TD Ameritrade was that good fit. So, the transparency aspect goes along with that custody because we are not custody-ing it, the transparency is, our client can easily go to the custodian. Like they get statements from the custodian, it doesn’t come from us. You know, they can always go on their account and see their investments in any given time. It’s totally transparent, there is nothing hidden whatsoever about it. The liquidity of our possessions is very important too. You look at 2008, for example, and actually, 2015 was another example of this. So, in 2008 in certain markets there was a lack of liquidity. In the institutional markets, there were a lot of these vehicles that were created where there was a lack of liquidity at the time when people needed it most. So if I am managing a portfolio, for example, and let’s say I have 80% of my portfolio in the S&P 500, so a very liquid bunch of investments, let’s say 20% in some sort of an illiquid vehicle, some sort of an institutional vehicle, and I want to liquidate that but there is no liquidity all of a sudden I have to search down in my S & P shares because I need liquidity, I need to free up capital to either pay back investors or whatever it might be. So, instead of selling the thing that I want to sell, I’m selling things I don’t want to sell. But the problem is, it’s not just me, it’s the entire market doing the same thing. So, if you want to know why the assets correlate, it’s because all these institutions own the same things. So, look at 2015 as an example, we started to see this idea which I call contagion, which is, effectively, the oil prices started to plummet. Well, if you owned oil assets, you couldn’t sell them because, you know, no one wanted to buy them because they kept going down so in order to have liquidity in your portfolio you sold something that wasn’t oil. You know, maybe it was Apple stock, maybe it was real estate, maybe it was, in some cases, oil companies. The challenge is when everyone trying to do the same thing at the same time everything correlates and liquidity dries up. Now, for us, when we manage money, I mean, we do a lot with alternatives but it’s a very separate part of what we do. The traditional portfolio, which is kind of really what we are talking about here today, the traditional portfolio is fully liquid. We have set this up specifically for the fact that if people need liquidity they can get it. Call me up tomorrow and say, hey, I need my money, I can just sell it and it’s done. Everything that we do is highly liquid. We only deal with the most liquid securities because of this very issue. When things go bad liquidity dries up. You don’t want to be on the other end of that. So that for us is extremely important. Kelly: Kirk, I know you like to work with CPAs and help them with their clients, just like you are helping me with my clients. Let’s say I have some tax and accounting clients that need what I think is a risk-managed portfolio, and the profile for that type of client is typically this, they have made their money; they have created their wealth; they don’t need to hit any home runs; they don’t even need to hit a triple, maybe a double, a single, they don’t need to strike out, and they sure as hell don’t need to be hit by the pitch,. That’s the typical client that many of us see. Kirk: I like the analogy, Kelly. Kelly: Thanks. Number one, preserve what they have, and number two, grow it. In that order, and what’s the best way for these clients to work with you, whether it be a CPA or one of my clients, how are we going to work together on this? They are located in say, Minneapolis and Kansas City, how do we work together? Kirk: First of all, a location I don’t find is all that important. I have been doing this for 20 years, most of my career I thought that I need to see somebody to work with them but in the last three years, I have kind of changed that kind of mindset around myself, because what I realize was, clients don’t want to see me. They don’t want to drive an hour or a half-hour to my office and then drive an hour or a half an hour back. Like, it is much more efficient use of their time to just get on a call and talk about these things. You and I are in different states and we work together just well. But the other part of what you were saying is very important, where you were talking about not hitting home run in triples. There are many types of clients. There are clients who are trying to build and grow their wealth and there are clients who are not, right? They just trying to maintain and to sustain their wealth. You know, it is funny, no one sends you a letter and says, hey, you are rich, right? There is no letter that the IRS sends you that says, hey you are rich, like, now you are going to start paying the rich person’s taxes. ...
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