August 2014- Our Current Portfolio Management Styles and the Approaches

By The Lerner Group on August 1, 2014

On December 5, 1996 Alan Greenspan characterized the then current stock market as being in a state of “irrational exuberance”. The S&P Index rose by approximately 100 per cent over the previous four years, and the implication of Greenspan’s remarks were clear: the market could fall sharply. And the market did fall as Greenspan predicted, but not for another four years. During this four year interval, the S&P Index again rose by approximately 100 percent.
No one describes today’s market as being in a state of “irrational exuberance”. Many may caution that interest rates are low, stock prices have increased, and political conditions around the world are uncertain. It would not be surprising if they share their views with you that the market may fall. However, mergers and acquisitions are proceeding at a rapid pace. The U.S. economy captured the winter slowdown in this year’s first quarter data, and a surge of stronger economic data is now being reported. A year ago the Federal Reserve was driving home the idea that a highly accommodative monetary policy was necessary. This is no longer the case.
We agree with the current market critics that the market can drop and that sometime in the future the S&P could be less than it now is. The question however remains “How much higher will the market rise before such a drop takes place?” The answer, of course, is that no one knows. We reached the conclusion a long time ago that our clients do not expect us to be able to predict the future.
Clients really want only three things from us: (1) don’t lose their money, (2) earn a steady return, and (3) invest so their assets increase in value over time as much as the market appreciates. Once we came to understand this truth, our management approach changed. We cut back our single focus approach of finding companies that represented a deep value opportunity and began to implement our current portfolio management style. This approach has three different components:
(1) The first component holds Growth Stocks, i.e. individual securities which we believe have the potential to generate relatively high returns. These securities are then continuously monitored, and when we believe the fortunes of a holding begin to deteriorate, it is sold and replaced.
(2) The second component holds individual Corporate and Municipal Bonds. These securities produce a steady stream of income that gives clients the option to deposit an agreed upon amount of money each month in their bank accounts for them to spend as they see fit.
(3) The third component holds Equity Income stocks. These are securities that pay a relatively high yield and also have the potential for a modest price appreciation. AT&T, for example, is in our Equity Income component. It has a current dividend yield of approximately 5 percent; it pays an annual dividend of $1.84 per share and sold in the $35 a share price range. We do not expect the price of the stock to either increase or fall sharply from its current level; however, if the market continues to believe that AT&T is likely to raise its annual dividend, its market price could increase even more.
Before we manage a client’s money, we try to hold a meeting and ascertain their cash flow requirements. Once we know how much money each client would like to receive each month, we can estimate the size of the bond and equity income component they need to generate their desired cash flow. The remaining funds can then be allocated to the more volatile Growth component of the portfolio and their current cash flow needs need not be jeopardized.
We began this letter to you by posing a question that is on the minds of many investors: Given the high level of uncertainty that is prevalent in the market today, how should they allocate their funds? We assume no client wants to lose, wants to receive a steady cash stream and wants to participate in the growth of the market should it continues to rise. Each client owns their own separately managed account, and no two clients hold precisely the same individual stocks or bonds.
Please call us and schedule an appointment if you would like to discuss how well your current allocation meets your personal needs and what changes you would like to see us make.