BURT ASSOCIATES, INCORPORATED-6010 EXECUTIVE BOULEVARD #900-
Volume 11 Issue 1
May 2001
THE YEAR 2000 IN REVIEW
By Dr. Marvin R. Burt, CFP
The year 2000, as well as the first quarter of 2001,
will be remembered as the year in which investors became sharply focused on
something which had been largely ignored by many of them: RISK. The most dramatic manifestation of this was
the spectacular bursting of the technology “bubble.” However, the correction in the stock market
went far beyond technology stocks and hit other high P/E stocks hard as well.
In a year such as 2000, as well as the first quarter
of 2001, the most important strategy is to protect one’s capital. Warren Buffett,
arguably the most successful investor in recent years, cites two “cardinal
rules” of investing: (1) Protect your
capital and (2) Don’t forget the first cardinal rule.
Now that Burt Associates has completed the analysis
of our performance for 2000, we can see what we have accomplished. Our portfolios ended the year in positive
territory, which confirms the wisdom of protecting one’s capital. We seek to participate in the upswing when
markets are appreciating, but protect our capital in
down markets.
Last year proved, once again, the wisdom of
diversification. For the previous
several years, investors were punished by diversification. The way to maximize your investment return
was to concentrate in
Fred Cornelius’s article on “Active Versus Passive
Investing” discusses an often
misunderstood aspect of investing. He describes how our investment approach
seeks to utilize the best features of both active and passive styles of equity
investing. Chris Rhim,
in his article on “Considerations For Active Bond
Management,” describes our active approach to bond investing. In “Required Minimum Distributions”
Christine D’Amato explains how the recent dramatic changes in distribution
rules affect your retirement planning.
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INSIDE Active Vs. Passive Investing 2 Considerations for Active Bond
Management 2 Required Minimum Distributions 3 Practice News
4 |
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Active
vs. Passive Equity Management – An Update
By Frederick
Cornelius, CFP, CFA
During
1999, the popular and financial presses inundated the investing public with the
advantages of indexing. This is not surprising because the S&P 500 gained
more than 20% per year from 1995 through 1999.
The flow of information was so “one-sided” that many individual
investors found it difficult to justify any investment other than an S&P
500 Index Fund. The period since 1999 has reminded investors that no single
strategy works all the time and actively managed investments have an important
place in a well-diversified portfolio.
We are very proud that 8 of the 9 actively managed domestic funds we
have owned for at least a year have outperformed their benchmark index for the
12 month period ending March 31, 2001.
In fact, at least 5 of the funds outperformed their benchmark by at
least 10% with two funds beating the index by 15% or more.
Our
philosophy is that an active and passive strategy need not be mutually
exclusive and, in fact, can be effectively combined to produce superior risk
adjusted returns. Our strategy is to
index those securities in markets that are efficient and actively manage those
assets in markets that are less efficient.
There
have been many studies that conclude that very few large capitalization, core
domestic equity managers outperform the S&P 500 index. Therefore, we have elected to index a large
part of our large cap sector by investing in the funds that mimic that
index. Conversely, mid-cap, small-cap
and international fund managers tend to have much greater success outperforming
their benchmark index; we therefore do not index these markets. Each of our actively managed funds focuses on
a specific niche in one of these less efficient markets.
Over
the short to intermediate term, the direction of the market can also have an
influence on the relative performance of active strategies vs. passive strategies.
Active strategies tend to be most successful in gradually rising, flat or down
markets and indexing large cap stocks can outperform when markets are rising
rapidly. Because we do not expect a
return to prolonged periods of 25% or greater performance for stocks, we are
quite confident that our diversified approach will capture the benefits of both
actively managed funds as well as index funds.
Considerations for Active Bond Management
By Christopher
H. Rhim, CFP
In
actively managing our bond portfolios, we strive to improve not only
yield-to-maturity (YTM) but also the quality of our bonds. We are proactive in trying to understand the
macro-economic world we invest in. By
staying abreast of leading economic indicators, corporate profit forecasts and
federal monetary policy, we hope to gain some insights concerning the direction
of interest rates and the business environment.
However, proper management must consider each client’s cash flow needs,
taxes, diversification, liquidity and risk tolerance. I will briefly discuss our rationale for
investing:
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YTM and Quality - Through bond swaps and an
understanding of the yield curve, we maximize return and minimize risk
exposure. We look to improve yield but
refuse to willingly sacrifice quality.
We seek those bonds that capture the most return for the shortest
maturity possible.
Cash Flow Needs – Higher yielding bonds
typically carry greater risk to the issuer and investor. By emphasizing total return (income and
change in market value), we attempt to compensate the investor not only with
income but also with an asset that appreciates over time. This is accomplished with high quality issues
which are more reliable payees of income, appreciate
in good economic times and can weather the storm in bad ones.
Taxes – Before investing new
money or selling current bonds, we achieve a thorough understanding of the tax
implications for each client. We attempt
to best utilize tax-sheltered accounts (IRAs, 403bs, SEPs,
etc.) for higher-yielding issues and, whenever possible, put tax-advantaged
Treasuries and municipals in taxable accounts.
Diversification – A proper mix between corporate, municipal and Treasury bonds is tailored for each client. We also diversify within corporates (by industry), municipals (between similar AA/AAA-rated issuers) and even Treasuries and other government-backed bonds like Government National Mortgage Corporation (GNMA) bonds. Like equities, we diversify in different types of bonds for overall portfolio safety. For most clients, we attempt to strike a balance between higher yielding (though slightly more risky), high quality corporate bonds and lower yielding Treasury bonds.
Liquidity and Risk Tolerance – The risk tolerance level
of the investor is an important distinction in each client’s portfolio. Those dependent upon a steady stream of
income along with preservation of capital will be weighted more towards AAA-rated
and government backed debt. While
Treasuries are the most liquid form of debt, we mostly trade in large blocks of
corporate and municipal bonds of the highest liquidity. Larger blocks of bonds provide us with more
favorable pricing on both sides of the trade.
Historically, liquidity for lower-quality issues has been known to
evaporate in times of economic distress.
We attempt to minimize this problem by limiting ourselves to larger,
high quality corporate and municipal issues.
Required Minimum Distributions - Revised But Not Really Simplified
By Christine A. D’Amato, CFP
In January of this year, the IRS surprised everyone
and issued new proposed regulations that significantly change the required
minimum distribution rules for qualified pension plans, IRAs, 457 and 403(b)
plans. The new regulations go into
effect January 1, 2002 but the IRS will allow taxpayers to use either the old
rules or the new rules for their 2001 minimum distributions (this is not
allowed, however, for qualified plans that have not yet amended their
documents).
In the beginning, everyone cheered at the revised
rules that were supposed to simplify the minimum distribution calculation. But before you run out and celebrate, there
are a few things you should be aware of.
First, don’t throw out everything you ever learned about required
minimum distributions. You still need to
start minimum distributions by April 1 of the year
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PAGE 4
following your 70½ birthday, the so-called
Required Beginning Date (RBD). The
method of dividing the prior year-end balance by life expectancy is still
used. Also, the 50% penalty still
applies to the required amount not withdrawn.
What changes is that there is one simplified MDIB
life expectancy table for everyone to use.
The only exception is if your spouse is your beneficiary and is more
than 10 years younger, then you can use the more favorable joint life
expectancy table. Another important
change is the use of the life expectancy of the beneficiary as of December 31
of the year following the owner’s death (and not just the beneficiary as of the
RBD). This creates enormous planning
opportunities for beneficiaries and estates, allowing children to disclaim down
to grandchildren (assuming contingent beneficiaries are properly
designated). In addition, if no
beneficiary was named, the balance can now be distributed over the owner’s life
expectancy just prior to death, thereby deferring taxes for longer than the
alternative 5-year period. But these
changes require that you closely review your estate plans, beneficiary
elections and disclaimer provisions.
Another significant change is that plan custodians
must now report the required distribution amount to the account owner and
to the IRS each year. A problem with this, that has been overlooked so far by the press, is that
custodians may not have enough beneficiary information to make the correct
calculation and may even report a penalty amount when in fact one is not
due. What the new regulations also do
not take into account is that taxpayers may maintain several IRAs at several
different custodians but only withdraw their minimum distributions from
one. There are many other questions and
concerns that have been raised about these new regulations - far too many for
this article - that may prompt further revisions to the rules.
Before taking your 2001 distributions, carefully
review with your advisors your calculations, your beneficiaries, and how these
new rules affect you to make sure you are minimizing your distributions and
maximizing your tax-deferral. And as
always, please call us with any questions.
The rules have been revised but not necessarily simplified.
