When I was about 12 years old, my
Dad decided it was time to expand my understanding of the Depression. He pulled out an old ledger book from the cupboard and opened it to a page that he had dog-eared. He explained that this ledger was from his Dad’s grocery store. I can’t recall the year, but it was during the Depression. He had me
read the page: … one chicken, two pickles, potatoes … and after each item was its price. I remember thinking, “How could a chicken cost only eight cents?” Also on that page, by the food entry, was a family name. My Dad explained to this clueless 12-year-old that this ledger was for families who had no food or money, and my Grandpa would let them charge food knowing that he had little to no chance of ever getting paid.

To my Dad the Depression was always yesterday, and I am sure he really wanted me to understand his Managing Manias experience of growing up during those times. But as the years passed, I began to realize that his seeming obsession with this time period was an even more important lesson of gratitude and generosity.

The same year that my Dad showed me the ledger, I had a Physical Education teacher, Mr. Schmitt, who also was a starter on the local university basketball team. I thought he was the coolest person I ever met. One day during recess, Mr. Schmitt had me and a few fellow sixth-graders line up at a flag pole in the school yard. He instructed us to climb to the top of the pole and then come down. My friend, Tom, was first. He jumped on the pole, wrapped his legs around it and hand-over-hand shimmied up and then down. Now that we all got the idea, could we climb

the pole and see who would be the fastest. After a few more successful pole climbers (and some very cocky sixth- graders), it was my turn. I was bound and determined to get up and down the pole faster than anyone else. Mr. Schmitt, however, had another idea. He instructed me to climb the pole using only my arms! I tried to argue fairness, but like the arguments with my Dad about eating all my food, I failed.

So I climbed up and down that pole using only my arms, and though Mr. Schmitt seemed unimpressed, I felt great about my accomplishment and started egging on my friends to do By Barry Hyman, MBA the same. Most couldn’t, so my ego grew. After all the dust settled, Mr. Schmitt pulled me aside and told me something that I will never forget: “In your life you will be asked to do things you never thought you could do, but you can, just like climbing a pole without legs.” As time passed, I realized that just like my Dad’s lesson, this wasn’t about me. It was a lesson of effort, ingenuity and persistence.

Frequently, I think about my Dad’s lesson of gratitude and generosity, and Mr. Schmitt’s lesson of rising above the challenge, and I feel very blessed. A long time has passed since then, and years have gone by in a blink of an eye. My Dad’s gone now, and I don’t know where Mr. Schmitt is, but I’ve learned that despite all of life’s challenges, being able to view each day with an attitude of gratitude, generosity and persistence has come in very handy.

Despite recessions, bank failures, massive government debt, terrorist attacks and other negative situations, the human condition continues to improve … as does our economic condition. Let’s all take a minute to reflect back, and I hope you will agree that we continue to make progress. Progress can be a bit slow sometimes, but maybe now we are learning a lesson in patience.

At FIM Group, our current strategy is built around a muddle through, lowgrowth overall economy. So you will notice that there are few banks, retailers and manufacturers in your portfolios. Those industries are highly affected by the hyper-competitive environment we now live in, especially because of consumers’ desires to “just say no” to a new TV, pair of shoes, bigger house or La-Z-Boy. There are pockets of strength, like telecommunications, food, energy, entertainment and technology, but it’s not easy for any industry. We can’t just buy windmills or an energy company. Nuclear energy is on its way out, and renewable energy is in, but as any seller or manufacturer of solar panels or windmills will tell you, the “permitting process” of a project (i.e., sourcing, manufacturing and logistics, and design) can take years and experience tremendous delays. To be a successful investor, patience is mandatory; it is required even if you’re right on the money, because markets are volatile and consumers are unpredictable.

When we review our portfolios, we certainly find comfort in the fact that we have constructed solid portfolios that should perform well in the long term. Currently we see slow to no growth (+/-2%) in the U.S. and throughout most of the developed world. This will affect both the emerging economies and the hyper-exporting economies – as all statistics indicate they will not have the torrid growth of the past. We realize that investing under a slow growth assessment and not a bullish stance has consequences. We believe now more than at many times in our history it is time to prudently and realistically look at the downside twice and upside once on each investment. Today is a time to balance opportunity-seeking with prudent risk management. We do not believe that the world will break into prosperity for all, and shrug off the banking, debt, deficit, regulations, wars, governance, poverty, unemployment, underemployment, distribution inequalities and entitlement issues that are worldwide. When it comes to the “how-to” of investing in a low-growth economy, you simply need to look for five things represented in any company’s stock:

1. Hard-working, ethical and strong management
2. Quality (perhaps even great) products or services
3. Solid financials
4. Excess returns (lots of free cash flow/profits)
5. A “million” other things to fall into place depending on the specifics of the investment – which is why you hire a qualified portfolio manager

A Tour Around a FIM Group Portfolio

First, let’s travel to India, the home of Bollywood and a place where much of the world’s high-tech industry takes place. We own a Singapore-based real estate trust that owns properties in the corridors of India’s thriving hightech industry. Ascendas India REIT pays a cash dividend of more than 7%, which we expect to grow over time. Ascendas India REIT has good, skilled management, a solid balance sheet, strong growth, is located in a sector where there are barriers to entry, and can accommodate the need for infrastructure to serve the high-tech and quality needs of domestic and foreign companies. From India, let’s take a walkabout to Australia. Nearly all our Australian investments are paying well in excess of 4% current cash dividends. We own the main phone company, Telstra, which pays a nice cash dividend of 9%, Westfield REIT, which has a global

* The stock market dropped approximately 50% from May 31, 2008, through March 1, 2009.
* Several financial institutions in the U.S. and Europe failed because of exposure to bad mortgages (subprime) and the securitization of these mortgages via a Wall Street product called credit default swaps (CDS).
* Financial companies named Lehman, Countrywide, Wachovia, Washington Mutual and Bear Stearns, along with many others, disappeared.
* Insurance giant AIG was saved by massive government injections of cash.
* The Reserve Money Market Fund broke a $1 when several companies that issued commercial paper defaulted.
* Iceland faced financial collapse only to be saved by an emergency loan from the International Monetary Fund.
* Beginning the week of October 6, 2008, the stock market closed consecutively lower each of the five trading days on record-breaking trading volume. The Dow Jones Industrial Average lost almost 18% in that week, allowing historians to name it “Black Week.” The Dow, which closed at values in excess of 12,500 in May 2008, closed that week at 8,451.
* By March 2009, the Dow reached a low under 6,500.
* The news media reported daily the number of bank failures and rising unemployment rate.
* For historical reference, the period was named the “Great Recession” in an effort to draw comparisons to the “Great Depression” of the 1930s.

I could expand this list and make us all sick just remembering the financial trauma of this period, but I’ll show mercy and move onto the subject of this article: Was this period a gift or a curse?

My opinion is that this period was a gift because it made us all more reasonable. Here’s why:

* Asset prices reset to more reasonable levels, which allowed investors to make investments that have long-term opportunity and good dividends.
* Companies became more concerned with sustaining their business long-term, so they became more efficient by reducing costs and debt, and they learned to make money selling less.
* Consumers understood the risk of borrowing too much, and that even the price of real estate doesn’t always go up.
* Consumers understood the need to save for a rainy day.
* The word “guarantee” is now met with a wise sense of suspicion.
* The reasonable value of an asset is now viewed more from a cash flow opportunity perspective than its closing price.

When this era ends and historians evaluate it, I am hopeful it will be viewed as a period when we took the necessary financial medicine and realized that we should only buy assets when they are cheap, save money to reduce risk, pay down debt with discipline and spend less than we make.

The basics should be obvious now to those who are living through this period. It makes for a great investment opportunity going forward, because we can now be realistic and not live in a bubble. The Great Recession was a gift to the rational and wise investor, and hopefully it eliminated financial goofiness, at least for awhile. The future looks better because it can now be reviewed with reason and wisdom, not foolish expectations.

“What?” The client asked.

“We wait. We collect dividends, and we let our investments grow.”

“But we have a new [former actor] president, interest rates are high, unemployment is rising, the dollar is getting crushed and inflation is out of control!”

“We wait.”

Years ago I remember having a conversation similar to the one above with a client. It was the last time I said, “Now we wait,” regarding investing, because he interpreted that statement as, “Buy ’em and forget ’em.” Nothing is further from the truth. At FIM Group we constantly monitor each holding, the macro environment, industries, government policies, each company’s products, services, strategy and competition. This is part of our normal business scanning. And we don’t worry when the price action goes against us. Not only do we not worry, but on the contrary, having done our research to give us deep conviction, we savor those opportunities to buy more of what has more value. As Barry Hyman points out in his article (see page 4), buying at the right(bargain) price is key.

In past issues of our newsletter, I have discussed “behavioral” investing, a topic in which I have been a believer long before economists and financial gurus considered it a science. Back then, we labeled it “mania behavior” or “emotional investing.” In the past I have also discussed the “dark horsemen” of investing: Recency effect (placing more weight on recent history than on the entire history); endowment behavior (our predisposition to hold onto our investments); heretics (misplaced inferences based on random events or experiences); and other perils of investing. Investors often want to trade companies – not based on their investments or worth, but rather on their price action. Thankfully Wall Street brokers readily oblige this desire, because trades result in new commissions after all.

“Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
– Benjamin Graham

Sadly, though, this behavior is at epidemic proportions, even for the wealthiest of investors. The June 10, 2011, issue of The Financial Times had an article titled “Self Control Is the Key to an Investor’s Life.” The author drew on a Barclays Wealth study of 2,000 wealthy investors ($2,500,000+ in investments) and found that many (40%) tried to “time” the market by selling and buying often. One-third felt they needed to buy and sell often to be successful. On the other extreme, two-thirds of the respondents said that they have bought illiquid investments (e.g., real estate, annuities, partnerships) so they did not have to make a “buy or sell” decision. 76% resorted to avoidance strategies such as avoiding the news, or not looking at their investment statements. I inferred from the article that the 2,000 investors surveyed had poor results.

Art of War

Does it take courage to invest? I wonder if it is skill or just plain common sense that guides the successful investor toward good, consistent returns. I think the following statement from the ancient Chinese military treatise Art of War sums up the point and compels me to replace “courage” with “seasoned expert”:

“Thus the expert in battle moves the enemy [emotions, in the case of investing] and is not moved by him [his own emotions].” – Sun Tzu

My 20-year-old daughter is a dive master, and I have been scuba diving for nearly 30 years. Over Christmas break we went on a cave dive. On the plane ride home, a woman overheard us talking about the dive and said, “Gosh, I could never muster up the courage [to dive in a scary, dark, water-filled cave].” My daughter and I looked at each other, and she turned to the woman and said something to the effect of, “When diving, you’re safe because you’re trained. You also have a dive buddy who’s both a dive master and an expert on the cave. You follow a rope to prevent getting lost, and when you have two-thirds of your air left in your tank, you head back to the surface where someone is waiting.” My daughter and I have done more than 100 dives each, and we don’t dive if the conditions aren’t right or we sense any danger.

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it – even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” – Benjamin Graham

We Will Be Patient With Our Holdings and Wait

There are more than 50,000 stocks, there are millions of bonds and there are tens of millions of other investments such as real estate, commodities, gold, etc. Some of these investments are worthless, and some are gems. Some are “safer” than others at different times, depending on the prevalent business, economic currents, investing climate and, of course, the ever-present emotionally charged investor psychology.

As Barry points out in his article, there are many great investments that have great characteristics – very compelling attributes as investments – but alas they are sitting on the “bargain table.” Thankfully, everything is cyclical, and eventually investors will be attracted into good, solid investments like those Barry highlights. Their prices will go up, and we will sell them when they get to a price that is too high based on a price-to-value analysis. In the meantime, we will collect our income and dividends, let management do “their thing” and we will, with diligence and strategic patience … wait.

Outright Gifts

Under the current tax rules, a grandparent can give up to $13,000 annually to a grandchild free from estate tax or gift tax ($26,000 per grandchild if both grandparents contribute). This method is simple and easy, but it has some drawbacks. First, you are giving up control of the funds to your grandchild, who could use them for a purpose other than college. Another drawback is an outright gift becomes an asset of the grandchild, which could reduce the amount of available financial aid. Federal financial aid formulas require students to contribute 20% of their assets each year toward college costs. Alternatively, an outright gift to the parents for their child’s education may be preferable, since parents are expected to contribute a maximum of 5.6% of their assets toward their child’s college costs.

Pay Tuition Directly

A great way to help pay for college costs is to pay the college directly. Tuition payments made directly to the college are not considered taxable gifts, no matter how large the payment. However, this applies only to tuition costs – room and board, books and other fees are not considered qualified expenses for this treatment. Direct payment of tuition does not count toward the $13,000 annual gift tax exclusion, so in addition you would be able to give your grandchild a tax-free gift up to $13,000 per year. Another advantage over the outright gift is that this method will ensure the funds are used for college. One drawback is the college may reduce the student’s financial aid by the amount of the payment. If this is a consideration, you should check with the college to see how a direct payment may affect eligibility for school-based aid.

529 College Savings Plan

This can be an excellent way for grandparents to assist with financing a grandchild’s college education. A 529 college savings plan is a state-sponsored plan that invests the money on behalf of the participants. Under current law, contributions to the plan grow tax-deferred, and withdrawals that are used for qualified education expenses are tax-free. Qualified expenses include tuition, room and board (must be enrolled at least half time), books and fees. It is important to note, however, that if funds are used for something other than qualified education expenses, the earnings portion will be charged a 10% penalty and taxed at your ordinary income tax rate. Grandparents can open an account and name a grandchild as beneficiary, or they can contribute to an existing account. One advantage unique to 529 plans is that a donor can consolidate five years worth of tax-free investing into a single year ($65,000 lump sum gift by an individual; $130,000 joint gift by married couples), as long as they don’t make additional gifts to the beneficiary in the five-year period. This allows for investing a lot of money up front that can grow for the grandchild. The funds can be used for any accredited college. You can join any state’s plan, but there are often state tax benefits, such as deduction for contributions, which provide an incentive to participate in your in-state plan. View the other advantages of a 529 college savings plan below.

Help with college costs is a wonderful gift to give a grandchild. Before giving away your assets, however, it is critical to ensure that your own goals and lifestyle expenses are adequately funded. Your grandchild has a number of other options available for paying for college – such as loans, scholarships, financial aid and work programs – and you always have the option of helping to repay loans after they have graduated, if the resources are available. Alternatively, your options for funding a secure and comfortable retirement if your resources have been depleted are limited.

Future changes in tax law will likely affect some of the benefits of these approaches. Feel free to contact a FIM Group financial adviser if you have questions or would like to further explore whether one of these options may be right for you.
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In recent years we have seen many examples of how companies management sacrificed shareholders for their own benefit (e.g., the “too big to fail” banks and brokers). We have also seen the eroding effect of noncompetitive labor agreements evidenced by how Michigan has lost thousands of jobs to other states. Now gone are the firms that risked their long-term stability to pump up their bonus pools, or said “yes” to self-defeating labor agreements because the short-term rewards were so extravagant that risking it all (and the future jobs of average workers) was “worth” it for the few. Some companies risk the stability of entire countries for the pursuit of growth – others will have two value systems: one for their domestic market and one for everyone else.Interdependence

Often, the stakeholders’ attitude toward virtue with regards to serving the other groups is “I must advocate for my group” – not realizing that there is an extreme interdependence among the groups. They all need one another. Ethical behavior toward one’s own group but not the others causes a diminishing value of the business. Companies’ and societies’ prescription for managing this tension are “rules.” They create a rules-driven paradigm that is “values-neutral.” For example, some well-meaning mortgage companies, investors and others created incentives to help everyone achieve the “American dream” of home ownership, and laws, rules, regulations and incentives/disincentives were created for this purpose. Because hindsight is 20/20, we see that this resulted in hyped property values fueled by property debts, more and more homes being built, and a completely false economy built on good intentions. Municipalities were certainly happy, because higher property prices meant higher taxes. Labor was happy because there were jobs. And adding to the fun, homeowners used their home equity like an ATM. As I like to tell my children, “A little ice cream is great – too much ice cream will make you sick.”

Laws and Practical Wisdom

There is no law that says, “You should live prudently.” There is no law that says, “Just say no to excess debt.” There is no law that says labor should ask for less or customers should willingly pay more. There is no law that caps prices on housing. We should not (and really can’t) have laws that force people to have common sense or Aristotle’s “practical wisdom.” Could we conceivably pass a law that makes it so that people won’t be silly, naïve, short-sighted or selfdefeating? How? Who would judge this? Last night, while researching “choice” on the Internet, I found a TED talk by Barry Schwartz about our loss of wisdom (www. ted.com/talks/barry_schwartz_on_our_loss_of_ wisdom.html). Barry discussed the need for Aristotle’s practical wisdom as an “antidote for a society gone mad with bureaucracy.” In the well-presented talk he elaborated on how rules often fail us and incentives can backfire (e.g., the U.S. housing fiasco), and how a return to practical virtues, common sense and “everyday wisdom” can help rebuild our world.

Values-Neutral

I often see this values-neutral “law” issue with investors, employees, management and other stakeholders. I believe “valuesneutral” is a practice. I also believe that companies and societies that thrive place a more balanced emphasis on realizing we are interdependent and in this together. The balanced attitude would place “doing the right thing” over “doing whatever it takes, as long as its legal” in the pursuit of success. Warren Buffett, CEO of Berkshire Hathaway, said, “I look for three things in hiring people: First, personal integrity; second, intelligence; and third, a high energy level.” He went on to say that if integrity is not there, then the other two don’t matter. I think that if you were to identify one core “value” that has affected FIM Group’s performance most, it is the fact that FIM Group is not “values-neutral.” We believe virtue matters, and I personally believe it has helped our performance. Through the economic panics and crises over the years we’ve had negative swings in our portfolios’ values, but we’ve also avoided complete loss caused by lack of ethics or virtue in the companies we invest in. As our clients are aware, we don’t invest in tobacco companies. Why? First, we don’t wish to profit from a product that kills people. There are plenty of investments that don’t kill people with their products. Second, integrity and virtue. Who works for companies that knowingly make products that kill people? People who say, “Yes my company has lied to the public for years about the [cancer] risks of our products, but you can trust us with your investment, because we are honest about our books and are virtuous in the way we treat our shareholders.”

Trust

I think that trust is part of the DNA of great companies. When you read about economic thought leaders like Adam Smith, Thomas Malthus, John Stuart Mill, John Maynard Keynes, Andrew Carnegie and even Milton Friedman, it is easy to wonder if the idea of trust as a basis of the “normal” business world’s landscape was just taken for granted like air, water, money, governance or marriage. I think that while trust has always been a “big deal” in the past, it might have been historically taken for granted as a normal assumption about business. Today more than ever we want to trust something. It seems like at every corner the behaviors of those we trusted – government, industry, business and even our sports heroes – have shaken the foundations. Going forward, I believe that companies that will thrive in the long-term will be driven by leaders, managers and employees who you can trust. A friend of mine is a leadership training consultant. She lives in Detroit, but when she’s in Traverse City we will usually have tea and discuss business topics. Our last conversation was about (as always) “leadership,” but specifically this time it was about leadership attributes and the characteristics of leadership. She outlined the 13 behaviors Steven M. R. Covey champions, and we added a few of our own based on our own values formed by our ethical, spiritual and religious influences. Trust, like “brand value,” is part of a company’s currency of success, especially in the new economy that is emerging due to the extreme transparency that exists today. Simply, companies that try to “hide” their lack of character will fail, because consumers will avoid their products. Companies earn people’s trust through demonstration, i.e., by “walking the walk.” And trustworthy companies will thrive.

Of course there are fools born every minute, and many will buy products and services from ignorant companies. Those companies will thrive for a short period. There will always be exceptions that can be pointed to prove that ethics and virtue don’t matter. At FIM Group, however, we are long-term investors and without a doubt believe that long-term ethics and virtue truly matter.
The More Things Change

Throughout history our religious leaders, philosophers and teachers have been consistent about the importance of ethics, virtue, and thoughtful, commonsense- infused action. Today’s world economy is moving at light speed compared to when Aristotle, Moses, Buddha and Jesus walked our planet, but the principals of moral behavior are as true and solid today as they were back when these folks walked barefoot on our earth. Of course, the natural tension between society, employers, owners and such is nothing new. Jesus threw the money changers and other unethical business people from the church steps, and Buddha spoke of the importance of right behavior and the noble characteristics toward purposeful choices. Today, consumers will choose companies they can trust. The best and the brightest will work for companies they can be proud of. Governments will want more, consumers will want a better deal and owners will want more profits. I guess some things will never change.