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C.H. Robinson

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No Offense, but Your Company Stock Probably Won’t Outperform the Market

Written by Matt Wright on .

Many employees have an affinity for their company stock, and at first glance this might seem to make sense. Who knows the company's prospects better than its employees? If you have pride in your employer and believe it will be successful, the desire to own company stock can be strong.

However, we have always counseled our clients on the potential risk of having too much invested in their company stock. After all, their financial lives may already be heavily tied into the company's success based on their wages, bonuses, profit sharing contributions, etc. Do you really want to put even more eggs into that same risk basket by loading up on company stock?

But there is more to it than that. The fact is that most individual stocks (and every stock is someone's employer stock!) will not outperform the stock market. A JPMorgan study1 covering 1980-2014 concluded that about 2/3 of the stocks underperformed the Russell 3000 index over the period. Even worse, 2/5 of all the stocks lost money despite the long holding period!

Even more recent research2 from this year shows that more than half of stocks since 1926 underperformed U.S. Treasury Bills, one of the safest and lowest returning assets you can buy. Since 1926! How is this possible? Don't we all know that stocks have dramatically outperformed T-bills over long holding periods?

Well, the answer is yes and no.

Yes, the stock market has done very well as this represents the aggregate performance of all stocks, winners and losers. But no, as it turns out that any given stock will have returns that vary dramatically from the market. But still, how is it that so many stocks can perform poorly and still have the stock market do well?

The answer is that a relatively small number of huge winners provide a substantial portion of the market's long-term return. Out of over 25,000 stocks analyzed since 1926, just 10 companies have produced 16% of all the wealth creation in the stock market (e.g., Exxon Mobil, IBM, Wal-Mart.) And 75% of the cumulative wealth creation came from just 282 stocks, a little over 1% of the total number.

Just consider Apple and Amazon over the past 20 years. Both stocks have gained more than 20,000% over this period, turning $1 of investment into more than $200 of gains. In comparison, an adept (or lucky) stock picker who managed to gain 10% per year (handily beating the market) would have seen $1 grow to a little under $8.

So what can we make of all this? What you'll hear from Wall Street's active management firms is that this is great news because their stock pickers are working hard every day to identify just the winners and avoid all of the losers. Unfortunately, history has shown that this endeavor fails more often than it succeeds, primarily due to the higher costs incurred. The other thing to consider is just how likely is it for a stock picker to hold onto one of the stocks long enough to achieve the massive returns? Very few investors hold onto a stock for decades and every stock goes through gut-wrenching drops over time that will test your tolerance.

Our conclusion is that it reaffirms the logic for a passive, low-cost investing approach. We humbly admit that we are unlikely able to pick the small number of firms that will drive the majority of market returns over the coming decades, yet we can still participate in their growth by owning broadly diversified stock funds.

So, back to the topic of buying company stock (or stock picking in general) – does it still seem to make sense? You may be right that your company is better than average, but as we've learned, that's not enough! Why take the additional risk when you may not earn any additional reward?

1 The Agony and The Ecstasy: The Risks and Rewards of a Concentrated Stock Position. J.P. Morgan
2 Do Stocks Outperform Treasury Bills? Hendrik Bessembinder

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Hedge Funds – Still Hedging Away Most of the Returns!

Written by Matt Wright on .

Have you looked at your paltry 0-1% savings account yield in the last few years and thought, "Gee, I wish I could get even less returns but with a lot more risk and give up access to my money for a multi-year period." No? Would it surprise you to find out that many investors are clamoring to do just that??

The HFRX Global Hedge Fund Index gained just 2.5% in 2016, but that's actually favorable to the 0.6% losses per year it has averaged from 2007-2016. Meanwhile, a low-cost, diversified portfolio of 60% stocks and 40% bonds produced returns closer to 5% per year over the same 10 years.

Hedge funds started out several decades ago and were initially a platform for a relatively short list of skilled money managers. Those managers had more control over their processes and strategies and were able to generate higher compensation for themselves than if they were working for a traditional investment firm.

As with any business model, success brought on new competition and the number of hedge funds grew significantly over the years. During the 90s bull market and even through the dotcom crash, the industry generally did well, producing returns similar to the stock market but often with less risk. And all the while the managers were taking in hefty fees for themselves that often dramatically exceeded what investors were charged in mutual funds or comparable programs.

So, of course, competition continued to intensify. Many of the newcomers were also highly skilled and used sophisticated techniques, but the nature of the financial markets was changing. The early hedge funds were able to exploit inefficiencies that disappeared over time as other investors came to see the opportunities. Nonetheless, they continued to perform reasonably well as stock, bond, and commodity markets all rose coming out of the dotcom bust.

The Global Financial Crisis was a turning point for the industry. The HFRX Global Hedge Fund Index lost 23.3% that year, which doesn't seem too hot considering a diversified 60/40 portfolio had similar returns, but many saw that as a success compared to the 37.0% drop in the S&P 500 Index. In addition, there were a number of notable hedge funds that bucked the trend and had substantial gains during this period by betting against subprime mortgages, bank stocks, etc. A flood of new money surged into hedge funds as many have spent years waiting for the next market collapse. So far, of course, that hasn't happened. U.S. stocks and bonds have done quite well, while the hedge fund industry has struggled. In recent years, a number of major institutions such as the California Public Employees' Retirement System (CalPERS) have been exiting the hedge funds space and their disappointing performance, but demand from other investors remains high.

Now, the first thing a hedge fund salesperson will tell you is that while the average hedge fund might not do so well going forward, they think they'll be one of the exceptions. Just keep in mind that a) that's what they say every year and b) every fund will tell you the same thing. In aggregate, the high fees of hedge fund strategies create a meaningful drag on potential performance. Given that there are over 10,000 hedge funds out there, some of them will of course do well, but what are the odds that you would pick the right ones? Access problems imply that your chances might not be very good. You see, there is some evidence that previous outperformers might continue to do well, but well established firms that you might want to entrust your money to most likely don't want your money at all. Some of them aren't taking new investors, while others have multi-million dollar minimums.

A niche area of the industry that gets past some of the access issues are the hedge fund-of-funds. These funds pool together money from many investors in order to diversify across a variety of managers and also meet some of the high minimum investments of in-demand managers. The downside is that this platform adds yet another layer of fees that make the hurdle of outperformance that much higher.

By this point, you can probably figure out that our conclusion is that hedge funds are not an ideal way to invest money, and we don't see any obvious reason why they might do better in the next decade than they have in the past. Competition will still be fierce, fees will still be high, and I didn't even get into the topic of undesirable tax consequences! All in all, we think it's more likely that all of your returns will be "hedged away" rather than your seeing significant outperformance.

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Preventing Identity Theft

Written by Becky Botzet on .

We are all well aware of big corporations being hacked and our information being compromised. Many, if not all of us have been victims of this and have likely been offered a year or so of free credit monitoring. It's important to monitor your credit; however, by the time you see something on your credit history, a new credit card has already been opened and likely used. And worse, credit monitoring will not notify you if someone other than you has filed your tax return!

As of March 5, 2016 the IRS had identified over 42,000 tax returns with $227 million claimed in fraudulent refunds. What's more, the IRS prevented the issuance of over $180 million in fraudulent refunds. If you've been one of the unlucky victims of this fraud, you know how it works. The criminal who has obtained your information is able to file your tax return early in the fling season and claim a refund. The IRS doesn't match earnings records until several months after it issues refund checks. When you file your return, the IRS lets you know that more than one tax return has been filed and the fun begins of sorting it out.

Unfortunately, there is not a lot you can do to prevent this from happening to you. The IRS continues to expand filters to detect identity theft refund fraud, however the criminals also continue to expand their abilities of committing fraud!
The best line of defense is to protect your personal information as best you can.

  • Don't carry your social security card.
  • Don't provide your social security number to anyone unless there is a legitimate need for it.
  • Shred your sensitive trash with a cross-cut or micro-cut shredder.
  • Don't leave outgoing mail with personal information in your mailbox for pickup.
  • Never provide personal information to anyone in response to an unsolicited request.

If you are a victim of identity theft, or at risk because your information has been breached, go to: https://www.irs.gov/uac/Taxpayer-Guide-to-Identity-Theft

In addition to credit monitoring, you are able to go a step further to protect yourself if your information has been stolen. You can request a Credit Freeze on each of the three Credit Reporting Bureaus (Equifax, Experian & Trans Union). This is a total lockdown of new account activity in your name. Laws vary by state. Minnesota charges $5 for each of the three Bureaus. To check your state, go to: www.consumersunion.org. You should also know you will need to unfreeze at the Bureaus to open an account and it can be cumbersome to start and stop.

Take precautions now to save yourself time and inconvenience later!

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The Fed’s Message to the Bond Market: Don’t Be Negative

Written by Matt Wright on .

The Federal Reserve has just raised its target interest for the first time in 2016 and only the second time since the Global Financial Crisis in 2008. Yields on intermediate-term and long-term U.S. Treasury bonds plunged during the first half of the year but have since recovered to levels a bit higher than they started the year.

Of course, yields still remain fairly low by historical standards and this is a global phenomenon. Believe it or not, U.S. interest rates are higher than much of the world's developed economies. When yields hit their lows during the summer, there were more than $11 trillion of bonds worldwide that had negative yields. Bondholders are willingly locking up money for multi-year periods knowing that they will get back less money than they put in.

If that sounds strange to you, you're not alone! In fact, according to basic economy theory, this was considered impossible until it started happening just a few years ago. It certainly calls into question the idea that economies and markets can be reliably forecast when something that was never supposed to happen is now a central feature of the global bond market. This supports our view that it is best to stick to a well-considered long-term plan and not try to change investment strategies based on your or someone else's guess about what will happen in the financial markets.

If you've come to realize that the forecasting game is just not working in your favor but don't know what do next, contact us today and we'll try to get you on the right path going forward.

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ETN vs. ETF - One Letter Can Make a Big Difference!

Written by Matt Wright on .

Do you have any ETNs or other unknown risks lurking in your investment portfolio? Not even sure where to start looking? Contact us today and we can help you sort it all out.

Concerns about Deutsche Bank's solvency have been in the news for the past few months. While the failure of any major bank would have serious implications for the financial markets, there is an investment risk that could hit a little too close to home if Deutsche Bank failed – and many investors may not even know they're taking this risk!

You see, Deutsche Bank is an issuer of a number of Exchange Traded Notes (ETN). The purpose of an ETN is to provide an investor the return of a particular financial index, less expenses. At first glance, this appears similar to an index mutual fund or an Exchange Traded Fund (ETF), but there is actually a critical difference. While index mutual funds and ETFs may have a similar goal in matching an index return, less expenses, they do so by purchasing a basket of securities in an attempt to produce those returns. In other words, an owner of one of these funds indirectly owns a small piece of the stocks, bonds, etc. that make up the fund.

This is not the case with an ETN and the term "Note" is what gives it away. If you buy an ETN, what you are actually doing is lending money to the ETN issuer (such as Deutsche Bank or a number of other financial institutions) that is in turn promising to pay you a return based on a specified formula. If an ETN issuer were to become insolvent, you have no pass-through ownership in any underlying index securities; you instead become an unsecured creditor in the company's liquidation and hope that you get most of your money back. Since investors do not get paid to take on this additional risk, we do not believe it is prudent to put money into ETNs.

Some fans of ETNs would say that is too conservative a view and that the better option would be to buy ETNs but then closely watch the issuer's risk over time and sell the ETN if the risk seems to be getting too high, as might be the case for Deutsche Bank right now. We have a number of counterpoints to this argument, but we'll just give one at this time: When Lehman Brothers filed for bankruptcy in September 2008, it was a surprise to the financial markets and the company still had an investment-grade credit rating. Lehman had issued three ETNs and there were ~$15 million dollars in them at the time of the bankruptcy. Investors in the ETN recovered about 9 cents on the dollar. In that case, someone was left holding the bag and took losses on a risk they were never paid to take on. Financial history is full of surprises and an ETN implosion is one that is easy to avoid so why take the risk?

Contact us today if you need help sorting out your ETNs and ETFs.

North Metro: 763.355.5873
227 East River Parkway
Champlin, MN 55316-5873

South Metro: 612.987.9112
5871 Crossandra Street SE
Prior Lake, MN 55372-3337

West Metro: 763.639.3425
322 Greenhill Lane
Long Lake, MN 55356

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