Mid Quarter Newsletter Q22017

Our Legacy of Stewardship

In reflecting on Lon’s rich legacy, no part of his work was more important to him than being the trusted steward of his clients’ financial futures. Stewardship is defined as the responsible management of something entrusted to one’s care. It is a position we hold in the highest regard. Beyond our charge of helping clients with financial planning and investments, our most important role is to be a trusted partner available to you and your family for any questions or needs.

Prior to Lon’s passing, he shared with clients that he was excited to unveil the updated brand and image for Morton Capital. Over the next few months we will be completing the project we started with Lon, including the below video on our stewardship philosophy. This is one of a series of five videos and outlines how we see our role as your trusted steward.

How Is Your Financial Professional Getting Paid?

Back in 1983, when Lon founded Morton Capital, the financial investment landscape largely revolved around selling products. The more products financial professionals sold you, the more commissions (read: money) they made. Charging only a single fee based on a client’s assets under management (AUM) was extremely rare, if unheard of. However, Lon saw early on that the only way to truly align himself with clients’ best interests was to be paid for his objective advice and not based upon how many products he was able to sell to them.

Today, it is much more common for advisors to be “fee-only” as opposed to charging commissions.  The challenge with the “fee-only” title, though, is that it may not tell the full story. For instance, an advisor at a brokerage firm may not directly receive commissions, but that individual may still be incentivized to make money for the firm as opposed to their clients. Brokerage firms are notorious for making fees in a myriad of ways, and in many instances, clients can’t see these fees anywhere on their statements. In a Wall Street Journal article published in 2014, it was found that individual investors trading $100,000 in municipal bonds over the course of one month paid brokers an average “spread,” or markup, of 1.73%, or $1,730. In today’s low-interest-rate environment, this could amount to an entire year’s worth of interest. Brokers could also be getting kickbacks from mutual fund companies to recommend their funds to clients. Again, these incentives don’t show up anywhere on client statements, but the concern is that those funds were selected based on the broker’s compensation rather than solely on their appropriateness for clients.

It’s essential to understand how financial professionals are paid in order to find out what factors could be guiding their decision-making. At Morton, we don’t get paid incentives for recommending any of our investments to you. Paramount to our process is getting to know you and your needs and goals first, then making recommendations based solely on what we believe is best for you. Just as Lon envisioned when he decided to create an advisory firm all those years ago, this approach puts the focus back where it belongs: on the best interests of the client.

ETFs and the Illusion of Diversification

With the recent proliferation of ETFs (exchange-traded funds, or vehicles that track indices or a basket of assets), investors are better able to get instant diversification and cost effectively purchase hundreds of stocks in one fell swoop. However, as ETFs have grown as a percentage of total stock market ownership, an unexpected result has emerged; namely, a positive feedback loop has developed as individual stocks now move up and down in lockstep fashion. This makes sense-when you buy an ETF that tracks the S&P 500, you are effectively purchasing all 500 stocks in the S&P index instantaneously, pushing all of their prices up at the same time. Similarly, when you sell that ETF, you are selling all 500 stocks simultaneously, pushing all stock prices down. No surprise that the correlation amongst stocks has moved up meaningfully in recent years. Just when you thought you “won” the diversification game by buying that ETF, you now simply own a bunch of stocks that move up and down together. This behavior will be further exacerbated in a nasty market environment (think 2008) as investors at large will sell their ETFs at a push of a keyboard button, thereby selling thousands of individual stocks in unison.

The age-old solution to diversifying beyond stocks is to add bonds to your portfolio mix. After all, bonds typically behave well during periods of stock market volatility. However, while the last 30+ years have seen falling interest rates and rising bond prices, our concern is that the next 30 years may be a mirror image, with rising rates and poor bond performance. In future stock market dislocations, we believe bonds may not act as the ballast in the portfolio that they were in the past.

Given the heightened political uncertainty in the developed world, coupled with extremely high valuations across most asset classes, we strongly believe an alternative approach toward diversification is essential. Morton Capital is a thought leader in this realm, having taken a unique approach toward diversification for decades. Fundamentally, most traditional asset classes are exposed to three main factors: 1) valuations (we live in a world of expensive valuations); 2) GDP growth (growth around the world is stagnant); and 3) interest rates (trading at all-time historical lows). It may sound counterintuitive, but we seek (rather than avoid) risk exposure to other areas of the economy to curate a well-diversified portfolio. In other words, we crave exposure to asset classes that will behave differently than stocks and bonds in a variety of market environments. Examples include exposure to reinsurance (natural disasters), alternative lending, and gold. Additional examples, where applicable for clients who can access illiquid vehicles, are private lending, real estate, and royalty streams. While investors at large are extremely complacent, as evidenced by very low volatility levels in the global markets, complacency is one risk that we aggressively seek to avoid as we are never satisfied in our search for truly alternative sources of return.

Information contained herein is for educational purposes only and does not constitute an offer to sell or solicitation to buy any security. Some alternative investment opportunities discussed may only be available to eligible clients and involve a high degree of risk. Additionally, the fees and expenses charged on these investments may be higher than those of other investments. Any investment strategy involves the risk of loss of capital. Past performance does not guarantee future results.