From the July 2008 issue of Wealth Manager Web • Subscribe!

July 1, 2008

For one wealth manager, bonds are the only game in town.

Asset allocation? Don't even think about it, says Stan Richelson of the Scarsdale Investment Group, Ltd., a Blue Bell, Pa. wealth management shop that he runs with his wife, Hildy. The only sensible strategy, he insists, is all bonds, all the time, for all clients.

Richelson is an affable fellow who just happens to have an extreme perspective on investment strategy-at least relative to most of his contemporaries in finance. Then again, he's only too happy to explain his reasoning: "I have a very dark view of the world," he admits.

The idea of building multi-asset-class portfolios for clients may be widely hailed as judicious, but the received wisdom draws a Bronx cheer from this fee-only wealth manager. His reasoning is equally curt. "It's all about wealth preservation," says Richelson, a tax lawyer by training who switched to dispensing financial advice full-time in 1991.

Richelson concedes that a bonds-only strategy invites a fair amount of inflation risk over time. His solution? Save more, spend less.

As for looking to some mix of stocks, REITs, commodities, and other asset classes for complementing bonds, the idea strikes Richelson as unduly risky. "I like individual bonds," he counters. "Why? Because they come due. Once you buy a bond fund, whether it's an ETF or an open-end or closed-end fund, you've moved into a quasi equity." Meanwhile, if a client is sufficiently wealthy to live off the income stream generated by bonds, there's not much point in seeking out higher risk, he reasons.

When Richelson speaks of bonds, he's talking about Treasuries and U.S. agency securities such as Ginnie Maes. He's also a fan of munis and, at times, high-grade corporates and even TIPS, but he avoids high-yield and foreign bonds. His preference for a particular type of debt depends partly on the particulars of his clients-who include both high-net-worth investors and those of more moderate means. But his controlling philosophy is always the same: Avoid risk by favoring high-grade domestic bonds, a strategy Richelson details in Bonds: The Unbeaten Path to Secure Investment Growth (Bloomberg, 2007), which he co-authored with Hildy.

For some perspective on his wary way of thinking, he cites the so-called "Black Swan" risk, a reference to two books by Nassim Taleb-Fooled By Randomness and The Black Swan-that explore the causes and consequences of unpredictable events and how they can wreak havoc on the best laid plans of mice, men and naive investors.

In a recent interview with Wealth Manager, Richelson elaborated on his bond-besotted investment philosophy, poking his finger at a few sacred cows along the way. "You've never heard this point of view spoken so forthrightly and with such passion," he asserts.

Richelson's approach to investing may be atypical, but that alone doesn't make it right, or wrong. It does, however, make it interesting, all the more so when you consider that Richelson has been around the career block a few times. Having worked for a large Wall Street law firm as well as several large corporations, this tax lawyer is well acquainted with the finer points of high finance. Perhaps he favors bonds because of his experience in the financial industry--or in spite of it?

In your book, you effectively dismiss asset allocation by advocating an all-bonds strategy. Isn't that a touch radical?

Let's first talk about the book's intended audience, which is the individual investor. We're talking to the man-in-the-street who's being seriously beat up by the financial services industry, and he has limited options. He can't do all the things that the Harvard Endowment can do [i.e., invest in conventional and alternative asset classes such as venture capital]. What can an individual do? He can invest in stocks, he can invest in bonds, he can make believe he's investing in real estate by buying REITs-which aren't real estate. He could go into exotic stuff and pay enormous fees that he doesn't see or know about. He can speculate in gold and other commodities, and of course he'll get his timing wrong.

What about mutual funds?

Yes, of course, but depending on which ones he's in, he might pay loads. And if he's buying small or foreign stock funds, he's going to pay fees that, according to [Vanguard's] Jack Bogle, are somewhere between 2 percent and 8 percent every year in addition, probably, to a front-end load. And an advisor may be laying another 1 percent on top of that.

Eight percent? Presumably you're referring to charges over and above the stated expense ratios?

Yes. Consider a small-cap foreign equity fund. Some of the fees are disclosed-management fees and expenses. But what you're not seeing are things like the trading spreads and the brokerage commissions. Add taxes and bad timing to the expenses, and the investor's cooked. He's never going to make any money in equities. He doesn't know what he's doing when he's buying real estate. What is he left with? I think he's left with bonds, and I'm talking about individual bonds.

We're in Pennsylvania, so if you buy a 10-year Pennsylvania muni at new issue, and you sit with it for 10 years, there are no taxes and there's no bad timing.

The first chapter of our book lays out this argument, which says that stocks have not outperformed bonds for the hypothetical individual if you adjust for taxes, expenses and bad timing. If you risk adjust for stocks and bonds, you see that bonds are a much better deal.

Just to be clear, you're not saying that bond indices outperform stock indices.

No, but I'm saying that the man-in-the-street can't get those [stock index] returns. No individual has ever gotten the Ibbotson 10 percent return on equities because investors pay taxes and fees, even if they don't suffer bad timing.

On the other hand, what kind of return can investors expect from a muni bond? Inflation adjusted, doesn't the long-term outlook for returns for munis look grim?

It is grim; that's the whole point. Everyone wants to say that you can average 10 percent after fees, taxes and so on [in stocks]. The people of modest means are screwed. If bonds are going to give them 4 percent to 4.5 percent tax free, how is anyone going to retire on 4.5 percent tax free? But you're not going to do any better in the other asset classes. It's all razzle dazzle and smoke and mirrors. The face of reality is this: If you can get 4 percent after tax [with bonds], I don't think the man-in-the-street is going to do better by going into 10 asset classes.

Some might say that the grim outlook you just outlined by way of munis strongly suggests that the solution is holding a multi-asset-class portfolio comprised of, say, ETFs?

We're going to see about ETFs. Wait `til another Black Swan of 1987 shows up, and then we're going to see if ETFs work. So far, they haven't been stress-tested.

Doesn't the risk of a future Black Swan event strengthen the case for broad diversification via multiple asset classes, as opposed to just one, as you recommend?

And you think the man-in-the-street should educate himself [on investing in multi-asset-class portfolios]?

Let's assume an investor is sufficiently educated, or hires competent financial help. In that case, what do you think about the concept of multi-asset portfolios?

I reject the concept. The whole idea of asset allocation is to maximize return and reduce risk. I'm starting with the safest investments, so I don't need to reduce risk. All you can say is that I'm missing out, possibly, on future returns, which may or may not be there.

In fact, I have a different way of looking at bonds. We have some very substantial clients, but we don't 'perform.' Nobody asks us for performance figures. Nobody asks, 'What's your performance over the last three, five or 10 years?' We don't do performance. What we do is cash flow. With cash flow, you buy a 10-year bond yielding 4 percent, and you know what the cash flow will be. When the bond comes due, and you reinvest, you're going to get more or less cash flow [relative to the previous bond's cash flow].

The world we live in is different than any world you've ever heard of. We say, 'If you're looking for performance, go find someone who'll trade.' On the other hand, we're going to get you the yield to maturity; we'll get you the best price; and we're going to charge you a very low fee.

That's the world we live in. We don't live in the world that you write about and that everyone else lives in, with all the correlations and bell curves. I reject all that. I don't think the bell curve is worth anything; I don't think standard deviation tells you anything.

What's the basis for your investment philosophy?

Have you read The Black Swan? That's what we believe. Taleb's Black Swan analysis underlies our entire way of investing and presenting ourselves to the public. We believe that you should be invested in the safest stuff because the rest of the stuff can't be trusted because of the Black Swan risk.

Taleb recommends in The Black Swan that you essentially put 85 percent [of assets] in Treasury bonds. With the remaining 15 percent, open yourself up to positive Black Swans-in other words, the really risky stuff in the hopes of getting a positive Black Swan, of getting a windfall. Essentially that's what we do, although I didn't come to this view from reading his book.

Isn't focusing so heavily on bonds the equivalent of making an active, highly concentrated bet?

Yes. We're saying, 'I don't trust [other strategies] for my retirement.' I've invested, aside from a little venture capital stuff, all of our money in the same bonds that we recommend to clients. I reject asset allocation and instead I'm investing in what I perceive as the safest asset class. We've become financially independent, without taking any risks.

Doesn't concentrating investments in the "safest" asset class insure that you'll do poorly over time because of inflation?

You're right.

What can you do to overcome that head wind?

I save more money. Inflation isn't going to be kind to any asset class.

What about gold or oil?

Do you recall gold doing nothing for 20 years?

Wasn't that a function of low inflation?

No, it's supply and demand. For some reason, gold fell out of favor. You could make a lot of technical reasons about why, but I don't believe in any of that. There were more sellers than buyers; nobody was interested in the stuff. I was never interested in gold; it doesn't pay me a return.

So, to your question about whether inflation is going to eat you up? Yes, inflation's going to eat up everybody, which means that you need to save more money.

James Picerno ( is senior writer at Wealth Manager.

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