This is the fourth piece in Seeking Alpha's Positioning for 2014 series. This year we have once again asked experts on a range of different asset classes and investing strategies to offer their vision for the coming year and beyond. As always, the focus is on an overall approach to portfolio construction.
Casey Smith is President of Wiser Wealth Management, a Marietta, Georgia-based fee-only fiduciary wealth management firm offering asset management, tax preparation, estate planning and financial planning services. Wiser's unique investing techniques have earned Casey speaking engagements at top ETF conferences around the world. When not running Wiser Wealth, Casey doubles as a pilot for an Atlanta-based commercial airline.
Seeking Alpha's Abby Carmel and Jonathan Liss recently spoke with Casey to find out how he planned to use ETFs to position clients across a range of healthy asset classes in the coming year.
SA Editors (SA): How would you describe your investing philosophy, broadly speaking?
Casey Smith (CS): We seek to invest in global long-term healthy asset classes using index funds, specifically Exchange Traded Funds (ETFs). Since 2004 our portfolios have been implemented using all ETFs. This has allowed us to keep the investment vehicle cost low, transaction fees low or zero, and liquid diversification into global asset classes. When building our core portfolios we focus five years out on our allocations, looking for threats such as rising interest rates, and adjust the portfolio accordingly. We do not make short-term changes due to market volatility, or what we call fear-based trades.
(SA): How do you define long-term healthy asset classes?
(CS): We define long term healthy asset classes as those that you can buy and hold and over a long time period, generally 10 plus years, you see a positive rate of return. This would include but is not limited to the S&P 500, 400, 600, International developed and emerging equities, and many bond categories. Assets that do not show up are leveraged, inverse funds and other assets that have to be actively traded.
(SA): As we approach 2014, are you bullish or bearish?
(CS): We are cautiously bullish. Two of our major 2014 catalysts have been addressed. The Fed has indicated a slow reduction in the pull back in US stimulus as the unemployment numbers improve. US politicians seem to have removed some of the political drama from the market by passing a budget and say that they will have a debt ceiling deal early in the New Year. This gives equities some more room to the upside.
(SA): What are the major catalysts for markets in 2014?
(CS): The biggest catalyst that affects the markets the most is the one that no one was predicting, which is why investors must keep within their risk tolerance and fight the urge to be greedy in up markets or overly fearful in the down cycles. The Fed's moves or wrong moves could be a major catalyst in 2014. As the US economy heats up and the unemployment rate comes down the Fed will have to make careful policy decisions as to not upset the housing recovery but also keep inflation at bay. Other catalysts are an economic reversal in Europe, and war in the Middle East that is less likely to occur but still should be watched with interest.
(SA): Which asset classes are you overweight? Which are you underweight?
(CS): We primarily hold core asset classes within the portfolios, however during a recent portfolio rebalance we did reduce our emerging market bond and commodity exposure. We currently have zero exposure to mid and long term US bonds.
(SA): To which index or fund do you benchmark your performance?
(CS): To the clients we report the performance of the S&P 500 total return as this is an index that most understand. When referencing the index we remind them that their risk tolerance may not allow them to track the index but instead look at it as a reference. Internally we like comparing our models to the S&P risk based indexes. These indexes also have ETFs that track them by iShares. We also used the raw index data that is used to create our ETF models as a reference.
(SA): How closely do you watch political developments when formulating an overall investing thesis/asset allocation mix? How concerned are you about the February 7, 2014 deadline for the debt ceiling issue to be resolved (again) in terms of client portfolios?
(CS): Thus far we have used every crisis caused by US political dysfunction over the last few years as buying opportunities on the equity side of our portfolios. So far we are batting 1000. Benjamin Graham said that in the short term the stock market is a voting machine. Over the long term it is a weighing machine. He was referring to stocks and not necessarily politics, but the point is that it's what the market performance is over the long term that matters, not the short-term political dysfunction. Warren Buffett was also quoted as saying be greedy when others are fearful and be fearful when other are greedy. This is a lot harder to execute if you watch the major business news networks. They are reporting on today, not 10 years from today. So, no we do not build portfolios that focus on the short term, that money belongs in a CD at our client's bank.
(SA): The 10-year Treasury yield has recovered a fair bit since we spoke this time last year but still remains at low levels historically speaking. With bonds selling off for the first time in years on fears of tapering, where have you been having yield-hungry investors turn for income in this environment?
(CS): You have to separate yield into two categories - bond yield and stock yield (dividends). At this point in time bond portfolios are under tremendous downside pressure. Short of an economic event that would cause the government to pump more money into the economy and the overall increase in the demand for treasuries, a bond investor utilizing a bond mutual fund or index fund stands to lose a lot of principal outside a short bond duration. At this point I am not concerned about bond yield but rather getting through the next few years protecting the principal. There are a few ways to go about this. One is simply holding only those bond funds that are of a short duration, specifically 3 years or less. You can purchase individual bonds and hold them until maturity. As long as the company does not default then your principal is repaid to you. Investors can also use a defined maturity bond ETF. This is a basket of 175 -200 bonds that will be maturing and/or called in the same year. If you reinvest the income back into the fund your principal is protected assuming there are no defaults within the fund. Many coming from the fund world like this option while those in individual bonds balk at the lower yield that diversification brings you. The point here is that holding a mid or long bond index fund does not make any sense with the current information on hand.
The second half of 2013 has not been kind to the alternative yield seeker portfolio. Preferred stock, S&P high dividend payers, REITs and other bond yield replacements have been sold off or have not have performed as well as the overall market with the prospects of the Fed tapering. While this is frustrating I am less concerned about this underperformance over the long-term. Dividend focused investing has a very strong historical success and I do not see this changing into the future. There will be value opportunities as some of these asset classes are oversold.
Investors should also not forget about growth when planning portfolio withdrawals. Using the growth side of the S&P 500 can also help replenish cash accounts during annual portfolio rebalancing. The growth side of the portfolio can help make up for low yields until interest rates do rise and we see higher bond rates.
(SA): How have changes to the tax code for higher net worth individuals affected your assessment of interest-paying investments?
(CS): After examining the changes to the code we felt that as passive indexers we had already worked hard to lower the negative tax consequences to our clients. In some cases it was better to take the higher interest payment and pay the tax versus using a Muni index fund. Purchasing individual Munis would bring us to a different conclusion, but your default risk obviously increases outside an index fund.
The tax efficiency of ETFs are great for high-income earners with non-qualified accounts. We feel that with the low cost of ETFs and their unique creation redemption process that we are able to keep the negative tax consequences minimal. The use of mutual funds in like accounts seems really, well not only 1990s, but also irresponsible given what this new era of investing offers us.
(SA): For investors with a long-term horizon and a greater risk tolerance, what is the correct asset class mix?
(CS): For a simple yet effective model for investing at a high-risk tolerance (high volatility), with low fees and global diversification, I would recommend three Vanguard ETFs. The funds are about as cheap as you can get and all trade for free at TD Ameritrade.
58% VTI - Vanguard Total Stock Market
30% VEU - Vanguard All World ex-USA
10% BSV - Vanguard Short Term Bond Fund
(SA): As a pilot, you know the airline industry well. There have been several major airline mergers in the last few years. How has this helped or hurt the industry?
(CS): The recent consolidation within the airline industry has made the major airlines profitable and hopefully more stable going forward. The cost of stability came through bankruptcy and through higher fares to the consumers in some markets. The shareholders of airlines have been rarely rewarded over the long-term. Airline stocks plays are usually only profitable for those with a sound exit strategy vs. buy and hold. With the current consolidation amongst the large carriers, investors should have less risk going forward. Airlines are now concerned about profitability rather than just market share.
How the small carriers will prevail is open for debate. The most successful smaller carriers have loyal niche markets not served well by the majors. This may allow for continued success or consolidation in the no frills, discount market.
The regional airlines which generally fly under the flag of the major carriers are being forced into cost cutting measures as less flying is available for the majors. This has caused a race to the bottom in how they bid for their work thus reducing profits. There have been a few consolidations at this level but none has been profitable. Future investment in this sector of the airline industry is speculative.
Ultimately I believe a healthy profitable airline industry is good for the US economy. Future threats may not be from industry peers but rather US politicizations. Foreign carriers, especially out of the Middle East, are expanding at a rapid rate. US Airlines need protection from their expansion into the US. One foreign airline has invested more money into wide body airplanes than it would cost to buy the entire US airline industry. There needs to be a US Aviation policy that allows US Airlines to compete globally in a marketplace that has state owned and supported airlines.
(SA): What advice would you give to a 'do-it-yourself' investor looking at opportunities in the present environment?
(CS): Successful investing involves keeping your cost low, maintaining a diversified portfolio and focusing long term. I will also add understanding and maintaining your risk tolerance. I see many individual investors using active portfolio strategies that they think is the key to beating the market or making money as the market moves in any direction. As I often say, it works until it doesn't. A recent academic study showed that less than 1% of professional money managers beat the S&P 500 over the long term. S&P also publishes a report that shows similar long-term results. The point here is for individuals to consider the use of index funds within their investment strategies, as this seems to win if you have good investment behavior.
Rather than pouring money into asset classes that have done well this last year, investors should also consider those that are currently underperforming, such as emerging markets through VWO or developed Europe through VEA. If value stocks become out of favor, look at HDV as a great source for dividends.
(SA): Any additional considerations you'd like to share with readers as they ponder their investing strategy in 2014 and beyond?
(CS): When building a 2014 strategy, build it to last longer than one year. The short term is hard to predict but buying long-term healthy asset classes has always paid off in the long term.
Disclosure: Casey Smith and some or all clients of Wiser Wealth Management own VWO, VEA, HDV, VTI, VEU and BSV.
To read other pieces from Seeking Alpha's Positioning for 2014 series, click here.