I’m on deadline, but I’ve been unable to write for four days. In 25 years, that’s never happened to me. A journalism professor once told me that a professional writer never gets writer’s block. I believed him. Until now.
I’m a New Yorker. I grew up in Queens, just a 20-minute subway ride from Manhattan. I went to NYU and Columbia, and I covered Wall Street at The New York Daily News. The attack struck my hometown. It killed my people. Shock, grief, and anger shut me down. But now my deadline is 24 hours off and I’m fighting back the best way I know: by writing.
Let’s start with the story that financial advisor Gregg Fisher told me. Fisher was in a conference room meeting with a mutual fund wholesaler when Michael Goodman, one of his staff, blasted through the door.
“He was out of breath and pale and looked confused,” says Fisher, a 30-year-old CFP licensee with a staff of 15. Goodman, a CPA and CFP, had been eating breakfast across the street at the New York office of the Federal Reserve when, as he was leaving, the first plane hit the North tower. “He said ‘The World Trade Center is on fire!’ ” Fisher said.
At first, Fisher thought Goodman was kidding. Minutes later, the second plane struck the South tower, creating the fireball that is now burned into the national psyche.
“Then, our building started to vibrate and I guess it felt something like an earthquake,” says Fisher.
Fisher’s office on the fourth floor at 90 William Street is a three-minute walk to the World Trade Center, three short blocks. “I went to the back of my office and looked out the window and I saw smoke,” he says. “We turned on the radio and got on the Internet. They were reporting the story but didn’t know exactly what was happening.”
Fisher and his colleagues knew they were under attack and debated whether to leave their office. “It wasn’t safe to go out because there was smoke and mayhem,” says Fisher. “It was happening all at once.”
Forty-two minutes after the second plane struck, the south tower of the Trade Center, a building that is more than twice the size of all the other city skyscrapers surrounding it, collapsed.
“I heard a loud explosion and our building is shaking again,” says Fisher, “and then I see hundreds of people running down Pratt Street screaming and a black cloud of smoke is following right behind them. At this point, I really thought that it was flames from the collapse that were coming next, and I thought all of us were going to die.”
Fisher says everything in his office went black as a mushroom cloud of soot and smoke engulfed lower Manhattan, turning a bright and clear day into night. Twenty-three agonizing minutes later, the north tower collapsed.
Fisher, whom I’ve known for about four years and who has always impressed me as being much older than his age, waited along with eight staffers, the wholesaler, and a client for the dust to clear.
After about an hour, he says, it got lighter outside. Then, an announcement over his building’s public address system: everyone should evacuate; air quality in the building was no longer safe. Wading through about four inches of soot and debris on the ground outside his office, Fisher says he and his co-workers began the long walk uptown to safety.
Frozen in Time
You didn’t have to be at ground zero, and you didn’t even have to be from New York to have those horrifying moments frozen in your mind. Like no other event since the assassination of John F. Kennedy, Americans forever will remember where they were and what they were doing on the morning of September 11, 2001.
I spoke with financial advisors from all over the country after the attack and they all have stories to tell. I don’t think it’s because many of the businesses in the towers were financial companies or because the towers are so close to Wall Street. It’s because so many people worked in those buildings that most Americans are bound to know someone who knows someone who works there. We’re all connected to that place.
Peter Langer, an advisor in Wilmington, North Carolina, was downloading data from Schwab and had the TV in his office tuned to CNBC when the tragedy struck. A native of the Bronx, Langer says the first thing he did was telephone his brother, who works at Lehman Brothers in One Liberty Plaza, just a block from the towers. Langer placed the call, and an assistant said his brother was not yet at work. Next, Langer dialed his wife, because her sister’s husband works for Fiduciary Trust, on the 97th floor of the South tower.
Langer says his brother-in-law had seen the first tower get hit. He walked down 30 flights of stairs to catch an express elevator to the lobby. While waiting for the elevator, the public address system assured workers that the danger had passed and to go back to their offices. His brother-in-law opted to go downstairs, but a colleague decided to go back to the office and is among those missing.
Langer would later learn that his brother also made it, but it was close. As he was walking into the building, Langer’s brother saw everyone leaving. Another bomb scare, he was told. He started toward an elevator but then thought better of it and turned around. When he stepped outside, he saw the second plane crash into the South tower. He watched horrified as people leapt from the tower. The investment banker then hitchhiked uptown. On the way, Langer says, his brother broke down crying.
In the aftermath of the attack, New Yorkers, once the most unflappable people in America, remain jittery. The stories, I believe, give us a preview into the period we are likely to face for at least the next few years, as Americans confront managing the terrorist threat that Israelis have tried to contain for years.
A day after the attacks, Joel Isaacson, whose advisory firm is located on Fifth Avenue and 42nd Street, was looking out his window right after someone had apparently called in a bomb scare. “People were running down 42nd Street screaming,” says Isaacson. “What happened hasn’t sunk in yet because you cannot fathom what it will be like to bury 6,000 people.”
Thursday night at around 1 A.M., I’m still glued to the TV and know that I could be in for another sleepless night. Suddenly, I hear a low rumble and grasp for the remote control to mute the TV. It was only thunder.
So where does this leave us? Has our world changed? Will the psychological scars heal? Americans are likely in coming days to regain the luxury of thinking about their money, but is financial planning changed?
“The world hasn’t changed,” says Bill Baldwin of Pillar Financial in Lexington, Massachusetts, “but our perception of the world has changed.”
“The principles of financial planning remain sound and have not changed,” says John MacIntyre, principal at Armstrong, MacIntyre & Severns, Inc. in Washington, D.C. “If anything, the attack reinforces what financial planners should always be doing: focusing people on personal goals and keeping them from getting wrapped up in the daily news and talking heads on CNBC.”
In the hours and days after the destruction of those towering icons of American capitalism, Harold Evensky, perhaps the nation’s best-known personal financial advisor, began calling clients and friends. Simply asking, “How are you?” would often lead to 10-minute answers, Evensky says. People would explain their reaction to what had happened to them–even though most of the calls were to the Coral Gables, Florida, vicinity where Evensky’s practice is located. “Just because people live here gave us no assurance that they were not affected by what happened,” says Evensky.
“We told clients that it was a horrible tragedy but not a financial event,” says Evensky. “Oil fields were not destroyed and Silicon Valley was still at work.”
Evensky says he warned clients that panic could hit the markets when they reopened and that a recession–a possibility before the attack–was, of course, more likely. “But recessions are part of normal cycles and their portfolios are designed for that,” says Evensky. “Our planning has always anticipated the possibility of recession and the only change outside of our normal process was that we asked clients for specific permission to make a change in their portfolios if we felt it was needed–without asking their permission first as we would normally.”
Evensky says that he, along with wife Deena Katz and a new partner, Bart Francis, made calls to money managers they hire to assess any damage they may have sustained. Was their physical plant intact? Had the grief and loss hit the staff personally?
But these were just the immediate issues. What of the longer-term implications? “The world may have fundamentally changed and we’ll need to assess that,” says Evensky. “Do I think there will be a flight to quality? Yes. Is that likely to be permanent? I don’t know.”
“I’ve argued for a long time that the market was overvalued and that we should expect lower returns over the next decade or longer,” says Evensky. “But if the market corrects hugely in the next few weeks, it might not be overvalued much longer and our expectations could change significantly if we go from a P/E of 25 on the S&P 500 to 14.”
It’s clear that airline, insurance, and transportation stocks will be extremely vulnerable but, says Evensky, “no one is likely to make money on anything so obvious.”
One thing the attack reinforced to planners and advisors is the notion that the world is unpredictable. This bolsters the importance of broad diversification of investments.
Where To Invest
In the aftermath, the alternative investments that make the most sense
Investment advisors have long built portfolios based on diversification, but many remain utterly focused on conventional styles and asset classes–growth and value stocks, large and small, and bonds and cash. In the two or three weeks before the September 11 terrorist attacks, I spent time examining nontraditional investments that can help diversify portfolios further. After the 11th, I followed up my research with calls to sources advocating nontraditional asset classes. The case for adding nontraditional assets to a portfolio became stronger after the attack.
I don’t feel great writing about the need to diversify beyond U.S. stocks at a time when the U.S. stock market could face turmoil. But you don’t diversify broadly because you know a market is going to go down. You do it precisely because you don’t know. You do it because markets are unpredictable. Let’s hope stocks soar. The most patriotic thing advisors can do right now is to act as a fiduciaries in helping clients preserve their wealth. So here are some ideas from planners I respect and their favorite alternative asset class managers.
Of all the out-of-the box thinkers I spoke with, Jeremy Grantham of Grantham, Mayo, Van Otterloo & Co. was most impressive. Grantham’s Boston-based firm manages about $20 billion with a value tilt, much of it in a family of mutual funds. Tom Connelly, one of the smartest personal financial planners I know, told me he had been implementing ideas from Grantham’s research with his clients for a long time, and at a conference this summer sponsored by the Association for Investment Management Research, Grantham had debated noted academic bull, Professor Jeremy Siegel.
Grantham has been bearish on American stocks for over two years, but after the September 11 tragedy has become reluctant to be bearish publicly. “It is unfortunate that this tragedy occurred when stock prices were pretty high,” Grantham reluctantly said in a September 14 phone interview.
In previous conversations, however, Grantham made a cogent case for why U.S. stocks were overvalued as the S&P 500 traded at about 25 times earnings. Grantham, who has studied investment bubbles for years, says that the normal P/E ratio for stocks over the last 75 years or so is about 14. But assuming that the trend line toward higher sales growth and slightly bigger profit margins extends into the next decade, Grantham says a P/E ratio of 17.5 would be fair value for the S&P 500.
To confirm his research, Grantham says that in recent months he asked 1,000 full-time equity professionals at AIMR and similar conferences and seminars if they thought the P/E ratio on the S&P 500 would drop below 17.5 in the next 10 years. While there have been seven no votes, the rest have been yes. “It’s safe to say that 99.9% of all equity professionals believe the P/E will drop a whole lot from where it is. I know nothing about the timing, but it would seem to guarantee a severe bear market.”
Grantham says he lost a lot of business as the market climbed in 1999 while he was bearish, but he was simply fulfilling his duty as fiduciary. Still, all through the market’s drop over the past 19 months, Grantham has found attractive pockets.
Grantham argues that emerging markets stocks are the best value right now among the numerous asset classes his firm tracks. Because they are riskier than U.S. stocks, he says, they should trade at a lower P/E and offer a higher return. According to the quantitative models GMO relies upon, for the added risk of emerging markets stocks, long-term investors over a decade should be rewarded with an average annual return about 50 basis points higher than on the S&P 500. With a fair value P/E of 15 versus 17.5 on the S&P 500, and a current P/E of about 12 on emerging markets stocks versus 25 for the S&P 500, the expanding P/E will result in profits on emerging markets. Plus, profit margins will expand to 3.8% and offer 0.8% of extra return while the possibility of a declining U.S. dollar will also boost returns over the next decade, according to Grantham’s research.
When reminded that investors over the past decade have bought into the emerging markets argument only to get badly burned, Grantham explains that people may be hard wired to behave clannishly. “It traces back to the need to hunt together to protect the clan against wild animals,” he says. “That’s what makes people susceptible to believing in the same broad general principles, and explains why everyone these days wants to invest in the asset class that has done brilliantly over the last 10 years.”
After the trade center disaster, Grantham said it was difficult to imagine how short-term attitudes toward emerging markets would be improved. “But emerging markets is the cheapest asset class by a wide margin,” he says. “Over 10 years, you have to believe they will develop faster than developed countries and you know beyond a shadow of a doubt they are cheaper than U.S. stocks.
“The third world is less directly affected than developed countries by the war on terrorism,” he says. “The third world is more vulnerable to a financial crisis, but that again is a short-term phenomenon. Emerging markets make sense particularly in an otherwise conservative portfolio.”
Grantham, incidentally, does not believe that the terrorist attack and any repercussions that might follow will have a significant impact on the 10-year investment horizon even for U.S. stocks. “The effects of these things tend to be short-term,” he says. “Over the next 10 years, we will have settled into a world of videoconferences. In the long run, you get to where you’re going with an investment because of the quality and number of people who show up to work, and the quality and extent of your plant–your productivity and growth of productivity–and I can’t think of any way these variables will be materially affected,” he says.
Grantham also is big on timber. Grantham says his research, based on government data, shows that the price of timber in real terms rose in each of the three great bear markets of the 20th century, including the deflationary period of the 1930s and the inflationary period of the 1970s. “This can be very comforting when you’re in a period of nervousness,” he says.
The 62-year-old Grantham says that in the three big declines in stocks of the 20th century–1917 to 1923, 1929 to 1945, and 1966 to 1982–the price of timber rose. And, what’s nice about timber, he says, is that when prices are down, you simply don’t cut trees, and unlike other inventories, they continue to grow and eventually get more valuable. Over the last 50 years, he says, timber has beaten the return on the S&P 500 with less volatility.
Technology has reduced the prices of other commodities over the past 100 years. But the world is using up its forests. “There will always be pressure for another ski resort, vacation home, or mall,” he says. “That means less area to grow wood.”
Investing directly is not simple, however. It means buying forestland acreage and engaging a timber manager. Alternatively, a forestland limited partnership, which is illiquid and can carry hefty management and administrative fees, can provide a direct investment if you can meet what is likely to be a hefty minimum investment.
GMO offers a partnership with a $250,000 minimum, but advisors may be able to meet that minimum if they have three clients that want to enter the fund. The fund owns about 20,000 acres of forestland in Kentucky, West Virginia, and Virginia, and it benefits from tax rules allowing all distributions to be treated as long-term capital gains. Alternatively, advisor may want to look at a REIT specializing in forestry, Plum Creek.
Another way of diversifying into nontraditional assets with a low correlation to stocks is investing in commodities. “Alternative assets like commodities are a fundamentally important part of diversification because they’re not correlated with equities,” says Jeffrey Schaff of Ardor Financial in Chicago. While many advisors seeking a commodities play to hedge their portfolios have chosen the Oppenheimer Real Asset Fund, Schaff’s exploration for a commodities hedge led him to Clyde Harrison, a partner in Beeland Management Company of Chicago, whose majority owner is Jim Rogers.
Rogers attracted great attention in the media over the past 15 years, first as a professor at Columbia who was also a successful professional investor and, in the last few years, for making lengthy adventure trips around the world–first on a motorcycle and currently in a customized Mercedes–with his significantly younger wife. Despite Rogers’ eccentricities and passion for fun, the ideas underlying the Rogers International Raw Materials limited partnership seem compelling.
Harrison explains that the U.S. has only 5% of the world’s population but consumes 25% of its oil. In the U.S. we have about two people for every car. India and China have 281 people per car. India, Harrison says, is now the No. 2 producer of computer hardware in the world, and the rest of the third world is also discovering capitalism and their economies are growing. Energy usage in India and China is growing at about a 10% rate annually, he says.
“If India and China were to use a quarter of the of the gasoline that the average American now uses, it would consume all 75 million barrels of oil produced daily,” says Harrison. “The guy in China who eats as much meat in a year as an average American eats in a weekend is growing more prosperous and as he improves his lifestyle, he is going to want to eat more meat and throw out his bike and buy a car.”
Rogers created an index that approximates the allocation of a dollar spent worldwide on commodities. The Rogers International Commodities Index (RICI) represents the investment results of futures contracts on 35 commodities. It has a 35% weighting in crude oil, 7% in wheat, and 4% in corn, copper, and aluminum.
Harrison concedes that raw materials have been in a bear market for about two decades, but an institutional fund based on the RICI is up about 52% since its inception in August 1998. Depressed prices have kept companies from adding to capacity to produce, and demand worldwide is bound to grow.
Harrison says back testing how the index performed during bad periods for stocks–such as the period from 1966 to 1982–yielded results that were “too goofy to send to anyone.” The new LP pegged on the RICI that is geared to retail investors carries much higher expenses than its institutional predecessor. It is still in escrow but the fund has been registered with regulators and could come public in a few weeks. With a minimum investment of $25,000, independent B/Ds are a likely sales channel.
Harrison says the war against terrorism “makes the fund interesting” for all the wrong reasons. “I used to tell people that oil is going to $100 a barrel in 10 years if we’re at peace,” he says. Now, “there’s no telling where oil prices may go.”
Harrison says the story is similar with platinum. “We get something around 90% of our platinum from Russia, and Russia is likely to fracture into 10 or 15 nations over the next decade,” says Harrison.
Of course, Harrison’s dire predictions may never come about. Still, diversifying into asset classes–with 5% of a portfolio in specialized areas such as this–could make sense if financial assets enter a long-term bear market lasting a decade or longer. Other alternative asset class plays that I discovered: a merger arbitrage fund, a partnership that capitalizes on risk transference, and inflation bonds.
Lou Stanasolovich, an advisor in Pittsburgh, likes the Merger Fund, which makes plays on corporate takeovers, mergers, and other deal stocks. When I first wrote about the fund seven years ago, it was tiny and unusual. Now, Merger has grown to over $1 billion in assets. While advisors like Stanasolovich who have an existing relationship may be able to access the fund, it has closed its doors to new investors. However, a new fund with a similar mission recently started up that is worth noting: Arbitrage Fund, which is run by John Orrico of Water Island Capital in New York.
When a deal is announced, the Arbitrage Fund typically goes long on the target company and shorts the acquirer, aiming to lock in the difference between the price of the target today and its acquisition price. Because of the hedging, this strategy is not well correlated with performance of the stock market.
When things go right, merger arbitrage can be a low-risk way of making respectable returns. For instance, Merger Fund has shown an annualized return of 11.8% over the past decade with an r2 to the S&P 500 of 25, according to data from Morningstar Inc., and its standard deviation is about one-quarter that of the S&P 500.
The Arbitrage Fund’s Orrico ran the merger-arb desk for a private trust run by Gruss & Company, an extremely wealthy family that originally made its fortune in oil and over the decades has gone into the investment management business with a specialty in merger arbitrage.
Orrico, 41, was the senior arbitrage analyst for five of his six years at Gruss. He says audited performance figures show that in 1995, the first year in which he was part of the team, his fund gained 11.13%. In 1996, he was promoted to senior analyst and the fund gained 15.95%, followed by a 14.48% gain in 1997, an 8.53% return in 1998, and a 17.36% return in 1999.
In 2000, Orrico left to start Water Island Capital. Orrico says his plan is to establish a public track record in the newly created mutual fund and then close the doors to new investors at $300 million in assets. Orrico says he would then focus on a private partnership using the same strategy, which could yield lucrative performance-based fees.
Deal volume in 2001 has been about half of what it was a year ago, Orrico concedes. However, he says the stock market downturn has resulted in some bargain-hunting companies seeking to buy competitors and there should still be plenty of deals to go after.
A Unique Asset Class
Another idea on diversifying into an unusual asset class came from Giles Almond of Matrix Wealth Advisors in Charlotte, North Carolina. Almond has been putting 5% of some client portfolios into the MLM Index Fund. In back testing the fund with his portfolios, Almond says “the optimizer really liked it.”
Jim Christian of Aspen Partners in Atlanta, which distributes the fund managed by Mt. Lucas Management, refused to discuss the private offering in any detail. But he would discuss the MLM index behind the LP. While the index may appear to be a commodities play, he says it is actually a play on price-risk transfer, creating an entirely unique asset class.
The index takes advantage of a market opportunity in commodities future markets dominated by corporate giants. For instance, if coffee prices are moving up, it’s good for coffee producers and warehousers but bad for Starbucks, Christian explains. Coffee producers want to go short because they are at risk if prices drop. Starbucks wants to go long because it’s at risk of higher prices. What Starbucks will lose by owning coffee while prices rise it can make up by being long in the futures.
However, Christian says the market will still be out of equilibrium because rising coffee prices will bring an abundance of coffee to market and more will be produced than Starbucks needs. That will make more and more producers go short and hedge, creating inefficiency in the market that Christian says is repeated day after day in commodities.
The MLM Index Fund capitalizes on the anomaly by going long or short in 25 commodities with equal commitments of 4% each. The decision to go long or short on a commodity is based purely on a technical formula: when prices over the previous 30 days exceed the 12-month moving average, the Index will go long in that commodity. When prices over the previous 30 days fall below the one-year moving average, the MLM index shorts that market. Data on the Index has been back tested for 40 years and money has been managed using the strategy since 1988, and audited performance results are available.
A Tip on TIPS
A final idea to leave you with is not quite as avant garde: Treasury Inflation-Protection Securities (TIPS). John Brynjolfsson, manager of the PIMCO Real Return Bond Fund, says an expected slowdown in the economy could result in monetary authorities being too accommodative. With the specter of Japan’s economic anemia in plain view, the Fed could be prone to erring on the side of liquefying the economy too much, which could inject a bout of inflation in the economy when business activity picks up.
TIPS diversify a portfolio of financial assets because they behave more like real assets, Brynjolfsson says. He doesn’t see any immediate inflation threat because the economy’s main problem, even before the war on terrorism, has been recession. But inflation protection, as with any of the diversifying alternative investments I’ve mentioned, is like car insurance. “You don’t buy it because you know you’re going to get into a car accident,” says Brynjolfsson. “You buy it because of the risk that you’ll be in an accident.”
My writer’s block is gone. I’m done with this story with plenty of time to make deadline. Fighting back works.
(See complete coverage of 9/11: Ten Years After on AdvisorOne.)