Resetting Your Investment Approach

[The past few years have provided us with plenty of world-altering events, horrifically bad news, and massive challenges. I think the big investment story though is not inflation or the pandemics effects on the economy, but how well many management teams responded to these challenges. It is not just what winds are blowing in your face, but what course corrections and strategic decisions you make to address them; maybe even finding a silver lining in some of those storm clouds. This may be the time for investing with an ownership mindset through fundamental analysis and deep understanding of corporate management. This confluence of events may well be shifting the investment universe into a stock picker’s market.

To explore this further, we reached out to Institute member Robert Scharar, President of Houston-based FCA Corp and President and Portfolio Manager at Commonwealth Funds , that invests with a very practical investment lens focused on business management and the business activity on the ground. His decades of direct investments and participatory business consulting expertise in a wide group of frontier and emerging markets provides a valuable perspective on investing through turmoil and is leading him to call investors towards a great investment reset of focusing on company managements and their business strategies.]

Hortz: How would you characterize investors reactions to the current market environment?

Scharar: There are lyrics from an old rhythm and blues song that comes to mind - “I hear you knockin, but you can't come in”. That lyric seems to summarize the reaction of many investors to the daily barrage of very troubling news on the economy, government spending, irrational policy actions, global turmoil, rapidly rising interest rates and fuel prices, and dropping equity, bond, and crypto markets. The disruptions of not enough baby formula, lack of or delays in obtaining vital goods, shortage of labor, and rising inflation fueled by war and supply chain breakdowns are not normal, yet investors seem gridlocked, hoping yesterday’s forever bull market will soon reappear.?

Hortz: What approach do you feel investors should be taking?

Scharar: I think this is a perfect opportunity for investors to reset and embrace a new investing approach from the previous “bull market” mentality which was often more reminiscent of gambling or being in the throes of a Ponzi scheme.?I feel this myriad of structural forces is creating the need for a return to a back- to-basics approach to investing. Now is a good time to urge investors to reexamine traditional fundamental investing principles and focus on company managements.

Hortz: How can investors determine the best corporate managers to invest in? What do you look for?

Scharar: We like companies that embody the 3 R’s - real companies, real products, and real financials.?The “real company” can be defined as one that embraces governance principles, transparency in reporting, communicating the business strategy, and providing a reasonable return to the shareholders.

Hortz: Can you give us an example or two by way of illustration?

Scharar:?These are two companies we own that are good examples:

South Port New Zealand Ltd web site clearly states “our purpose – to facilitate the best logistics solutions for the region”.??It has built a successful business model around supporting trade in the “Southland region” of New Zealand while returning cash to shareholders as dividends and deploying the retained earnings to add to the infrastructure to meet changing needs and take advantage of new opportunities.

Harleysville Financial Corporation has been providing banking services for over 100 years to its Pennsylvania neighbors.?The board and management’s stewardship have been able to continue the contribution to a community only a truly local bank can provide and at the same time rewarding shareholders while “honoring the safe and conservative principles that have served us well over the years”.

Hortz:?What else are you advising your firm’s clients to do or think about to guide them into this Investment Reset??

Scharar: Some key elements of what we discuss include:

1.?As to financial assets, focus your portfolio on quality companies with strong management teams. ?Use open and closed end funds to acquire diversification of issuers or to hold riskier or more boutique assets for diversification purposes and access to manager expertise. ETF’s can be useful in gaining sector allocation.

2.?Investment allocation means more than just in domestic equities or fixed income. Include global assets and alternative opportunities. Avoid unmanaged allocations to funds or ETFs that look only to the issuer market size.

3.?Buy more individual stocks and bonds, especially when you are buying investment grade fixed income or larger cap stocks, versus index funds as this reduces your portfolio expenses and can help you differentiate your returns.

4.?Be mindful of the impact of market sector allocations. Through early July, the S&P 500 average performance was down over 19%.?Of the 11 Sectors, 7 performed better than the average and 4 worse.?The range was between a positive 23% + for Energy to a negative of over 30% for the Consumer Discretionary Sector. Market performance takers who just bought the index did worse than 7 of the 11 sectors.

5.?Look at your investment allocation as a part of all your assets, not just by your brokerage account.?For example, if you have bank instruments, a treasury direct account, investment real estate, or life insurance cash values, then consider these as part of your overall allocation.

Hortz: What risk management measures should you take in this environment?

Scharar: Here are some points I recommend:

1.?Don't confuse gambling with investing.?If you can't explain or understand what you are buying, don't buy it.?

2.?While good quality stocks can go down in price, the quality aspects of the firm help them recover so align with good managements.

3.?Develop your own 3 R’s of searching for real companies, real products, and real financials and apply a few basic tests to your investment decision process.

4.?Be sure you have access to adequate cash-like assets to cover your expenses for several years in case asset values continue to decline and we end up in a recession.

5.?Have more than one deposit institution and electronic funds transfer set up to move funds quick if needed.

6.?Passive index investing is essentially a market performance taker - great in up markets, painful in down markets. Important tip here is to be aware of retirement accounts. Since many retirement funds only provide passive options - often only with broad market indexes like the S&P 500 and very little opportunity to manage the fixed income- keep this in mind as you construct your client’s entire portfolio outside of their retirement accounts.

Hortz: Any other thoughts you share with investors?

Scharar: Take stock of where you are at. We always have our clients prepare at least annually a financial inventory.?Many people look at their investment portfolios in a vacuum. You need to list everything, bank accounts, real estate, insurance and pension benefits, annuities, private investments, personal property and trusts of which you are a beneficiary, and detail on what and who you owe money to. The assets less your liabilities represent your net worth.?You should track this from year to year

?Categorize these assets between those that are lifestyle and those that are investable.?While lifestyle assets like your home may grow in value, until you dispose of them, they are a user of cash flow.?Investable assets can produce cash flow and or appreciation for current or future needs.?

Access your spending needs and what is important.?Are these sustainable on your current cash flow?

?Don't forget to factor in the income taxes. Be tax smart - with ordinary?federal tax rates at up to almost 40% and some states over 10%, you need to consider different ways to minimize, eliminate or defer taxes. Take tax considerations into account when repositioning assets or taking more than your required RMD from you IRA?

Once you understand the above, you are in a better position to determine the returns, risks, and types of investment products you can use.

The?Institute for Innovation Development? is an educational and business development catalyst for growth-oriented financial advisors and financial services firms?determined to lead their businesses in an operating environment of accelerating business and cultural change.?We position our members with the necessary ongoing innovation resources and best practices to drive and facilitate their next-generation growth, differentiation, and unique community engagement strategies.?The institute was launched with the support and foresight of our founding sponsors – Ultimus Fund Solutions, NASDAQ, FLX Networks, Pershing, Fidelity, Voya Financial, and Charter Financial Publishing (publisher of?Financial Advisor?and?Private Wealth magazines).