The Dividend Cafe - TBG Investment Committee Outlook - Week of January 13, 2020

Episode Date: January 17, 2020

Topics discussed: Managing Director, Partner Deiya Pernas and Director of Equity Research discuss the TBG client portfolio construction and infrastructure, equity and market hightlights of the week. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Okay, good morning, everybody. My name is Dea Parnas. This is the Dividend Cafe podcast here with the Investment Committee. I'm joined here with Julian Frazzo. And unfortunately, we're missing the rest of the Investment Committee. We're missing Robert Graham, Brian Seitel, and David Bonson. But we are committed to doing this weekly.

And we have here what I think is a pretty differentiated topic that we've discussed back and forth. So hopefully it is insightful to our listeners and our clients. And really the format of today's podcast is going to be, we're going to give a macro update at the end, and Julie's prepared a pretty comprehensive macro update for you. And we're also going to talk a little bit about a topic that goes pretty unsung in our group, in our business, which is really the infrastructure. We are getting ready to tee up and we're getting ready to execute our rebalance, our book-wide rebalance.

And we're going to be trading about $300 to $400 million worth of securities. And we really want to talk about exactly how we go about doing that, what's involved in that process, the investments we've made, and how we're able to say with conviction when we onboard a new client that we're going to be able to provide them the portfolio management our group has to offer. The solutions and analytics department does a number of things. We do security analysis. We do performance reporting. We do trading.

We do manage your due diligence. And one of the other things we do that goes unsung and unseen a lot of times is the infrastructure. And the infrastructure is really what ensures that now at over $2 billion in assets while also not losing anything on the customization side for clients. And the infrastructure is what ensures we're able to do that. And in order for us to understand how the infrastructure is going to do that, I want to talk about two concepts, and I'm going to define them. And the two concepts are really prescribed asset mixes or asset allocations and model portfolios and how those two link together to achieve that level of scale and customization. So we'll start by prescribed asset mixes. What is a prescribed asset mix or asset allocation? I'll use those terms interchangeably. Simply, a prescribed asset mix is the proportion of assets that we deem appropriate for the client the highest likelihood of achieving their preferred outcome.

And how do we arrive at the asset mix for the client? Well, the wealth advisor has to sit down with the client, gather the proper financial information, whether it be the tax, liquidity, concentrated stock positions, risk tolerance. Using that financial gathering session, they then, in accordance with the investment committee, come up with the prescribed asset mix. And why is it important to talk to the investment committee? The reason why it's important to talk to the investment committee is our conviction level for different asset classes are not always constant. Return expectations and risk profiles for asset classes are not always constant. Return expectations

and risk profiles for asset classes are not always constant. Let's say in the past, we thought maybe a 60-40 equity fixed income portfolio might be the right asset mix for a client given their goals. Maybe now is maybe 60-30-10. So risk and return profiles are not always constant. And it's important that the investment committee, in accordance with the wealth advisor who gathers information on behalf of the client, is able to embed those expectations and reconcile the client's financial situation in order to come up with a asset mix. Now, what's important is the asset mix is set at the household level. It's set at the client level. And we monitor that asset

mix to make sure it's not straying too far away from certain tolerances. So every single client throughout an entire book of business has a prescribed asset mix. A little tangent here, the prescribed asset mix is not always something that stays constant. It's updated based on, like I said, market views, the client's financial situation. It's something that can and will change. But whatever it is at the moment is something that we monitor. So if the client's current asset makes moves a little bit due to market movement, we want to make sure it isn't too far away from those targets. And their tolerance is set in place to do just that. And like I said, they're there for every single client throughout an entire book of business.

So now keep in mind this is set at the household level. Now what composes a household is accounts. So every household has underlying accounts. It can have anywhere from one to I've seen over 20 accounts per household. And here's where model portfolios come in. Accounts are assigned to model portfolios. Households aren't assigned to model portfolios. Accounts are.

Now what is a model portfolio? A model portfolio is essentially an actively selected collection of securities with optimal weights. The securities in a model portfolio can be equity, fixed income, or alternatives, or any mix of those. You can have multi-asset models. through our entire book of business, which composes households, is assigned to a model portfolio. Now, I'm not talking about accounts that we don't advise on, cash accounts or concentrated stock accounts. I'm talking about accounts that we tactically advise on those assets. Those will be assigned to a model. When we assign the accounts to the model portfolio, we're doing this while keeping in mind the prescribed asset mix. Assigning the accounts to the model portfolios helps us arrive at the proper asset mix. We roll it all up.

So let's say a household has three different accounts. You assign the accounts to different models. And when you're done, you want that to be the 50-40-10 or 60-40 or whatever you've prescribed. So now where does the rebalance come in? you've prescribed. So now where does the rebalance come in? If you have prescribed asset mixes and you're monitoring them to make sure they're within tolerance, where does the rebalance come in? So the rebalance for us is mainly a risk management slash housekeeping tool that we use. So throughout the course of a year or any period of time, the household, the weightings of the household, far as the assets go, will move according to the market. So maybe you have a prescribed asset mix for a household at 50,

40, 10. And through market movement, now that is 52, 38, 10. Maybe that's still within your tolerance where it doesn't alert the investing community that we need to make a change, but we still like to bring that risk down and bring it to the prescribed asset mix. We do so annually. It's a bit of a housekeeping item. Like I said, a bit of a risk management tool. It is calendarized. So we generally do it at the beginning of every year, but the rebalance also doesn't have to be something that is used as solely a risk management housekeeping item. It can also be used to risk accounts up. And I want to point to, if you remember, there was significant market weakness in Q4 of 2018. we knew very well that we would be adding substantial equity exposure. We added close to $100 million worth of equity exposure in 2019, at the beginning of 2019. And we knew that the rebalancer would do that. So that was used almost tactically and also as that housekeeping item that I described. But it definitely wasn't bringing anybody's risk down. If anything, it was

replenishing the appropriate amount of risk in client portfolios. Now to fast forward to the rebalance of 2020, what we've done, we've adjusted clients prescribed asset mixes slightly to make sure that we're not going to be buying equities on a net basis. We don't want to be adding fixed income on a net basis. And we want to make sure if we're selling a little bit of equities, given equities perform really well, that money isn't going to be going into fixed income because we're not exactly huge bulls on fixed income. We do think it's a necessary part of a balanced portfolio, but we're not huge bulls on it. So that gives everybody an idea of maybe how we use infrastructure to ensure that the right kind of portfolios are set at the household level.

And we're helping and monitoring to make sure that clients are moving along to reach their goals. Also, what's important is when we do hit that rebalance button, we're trading hundreds of millions of dollars worth of securities. And we want to make sure that we are speaking with our custodial partners to make sure that these different trades on certain ETFs or even stocks are being executed in the right way. So there's a significant amount of preparation that happens where we're talking with our equity block trading desks at Fidelity or at Schwab, but we have to have discussions with them where we tee this up ahead of time to make sure that these trades are being worked

in the right kind of way, whether it be through a volume-weighted algorithm or a time-weighted algorithm or whatever have you, to make sure that we're getting the best fills possible. I mean, I know that was a bit quick. I just wanted to talk a little bit about how we ensure that all of our clients are getting the right type of portfolio management and everybody is assigned to the right process. And those model portfolios are in place for every single client. Those asset mixes are updated regularly and are there for every single client. Hopefully, listeners get an idea of the infrastructure side of our business, something that is a little bit behind the scenes, but extremely important. We wouldn't be able to run a successful enterprise without it. So I'm going to conclude that infrastructure topic and I'm going to pass it off right now to my man, Julian Frazzo, who's prepared

a pretty comprehensive market update, and he's going to take it away. All right. Thank you, Dave. It's very interesting to me to understand as well all this that's happening in the background. And I guess I wanted to ask you maybe just one question. I don't know if that'll be of interest to the listeners, but how would you compare this year's rebalancing to last year? I think last year, you say the market was very different. The market was down. You went heavily into equities, I guess,

to capture that movement down compared to other asset classes. This year, all asset classes moved together, moved up a lot. So I guess equities moved up more than the other asset classes. That's why we ended up, I guess, in the portfolio, with a lot more equities than in the benchmark. So how would you compare? What would it be like this year compared to last year? Yeah, and if you're not really changing allocations, what a rebalance is always going to do,

it's going to sell what's really performed better in the portfolio and buy what didn't perform as good in the portfolio. And if we didn't change anything, we would inevitably be selling a large amount of equities and we'd be buying fixed income. So really understanding that we don't want to do that. And we made the adjustments to make sure that at a book level, we're not going to be net buyers of fixed income, really. What was different about the rebalance of 2019 was more of a market call in a way. We wanted to enhance exposure to equities as a result of the rebalance,

where really at the end of this year is we just want to make sure we're not large net buyers of fixed income, and we want to bring clients right in line with a prescribed asset allocation. So even though it's happening at the same time of the year, the intent and what we, as far as exposures go, is a bit different. Interesting. Thank you. Okay. Well, now if we move on and talk about what's happening in the market, we're halfway through January and equity markets are off to a strong start, I guess you could argue. It's like a continuation of the momentum we've seen in the last quarter. The S&P is up already 2.3% for the month. I think the Dow Jones crossed 29,000 yesterday.

The S&P just crossed 3,300 today. The volatility, as measured by the VIX index, is really at low levels. So, you know, it's in the 12s. It might be going to 11%. The 10-year is at, you know, 1.8%. The yield curve un-inverted back in October. Inflation is mild. So, you know, all the, I guess, all the lights are green at the moment.

And we had even a first shock, I guess, like with the iron, you know, escalation and de-escalation in a few days and had very little impact on the market maybe for one evening after market. And by the next morning, I remember David was saying, let's see what happens overnight. And by the next morning, he was right that futures were off and were back up

and the news was already digested. So it's been with a strong stack of the year i guess what we do in the investment community and what i do in particular and with david we spend a lot of time you know keeping an eye on the macro and the micro as well so macro really what matters always the same things i would say number one is is the fed and it looks like at the moment now the fed this year is on hold so the the assumption is that they shouldn't be such a big part of the equation this year. But there's still a few question marks. The market is at the moment not pricing any rate cuts or rate increases. Until June, at least, you have a very big likelihood

of a stable rate environment. When you look at the projections for December, it's interesting that at the moment, the consensus is that only 40% are assuming that the rates will be where they are today. Actually, you have 6% assuming one rate hike and 35% assuming one cut. And actually, if you add one cut or more, you get to a majority. So it's still early days.

It's December. So, of course, a lot of things could happen between now and then. But at the moment, there's a majority of expectation for one or more rate cuts at the Fed by the end of the year. So we'll see what happens there. The other thing, I guess, to monitor is what's happening in the repo market. I mean, the Fed clearly studied what's a QE for, that they don't want to call that. And they're going to try to pull the plug off slowly.

I mean, they were at $35 billion since mid-December of repo purchases. And now they announced in the last few days that they're going to try to reduce that by $5 billion starting February. So we'll see how it goes, if they're able to take away liquidity from the market, because that was one of the big reasons, we believe, why we've seen this rally at the end of the

year. So that's the Fed. Then, of course, you had what happened yesterday with the U.S.-China trade war. And we had this phase one deal signed. There's a lot of details. I don't think we want to go into that, you know, but he covers a lot of things. So he leaves $360 billion of tariffs in place. And there's chapters on intellectual property, on technology transfer, on agriculture, on financial services.

There's also something on currency, expanding trade with a big number. And that's $200 billion. That's a question mark whether or not it can be achieved. There's a chapter on the G-Spot resolution, so we'll see how this goes. But I think what's more important is really to realize that the financial conditions in the U.S. are loosening based on that deal. The yield curve un-inverted, actually, the day the U.S.-China deal was announced in October. So, you know, it's probably even more than the deal itself.

It's the sentiment, you know, that's important that I guess has changed completely, the sentiment in the market. And I guess with economic actors being more confident, it just helps as well. So I guess we'll have to monitor that as well. I guess Trump, I think, talked about the question mark about the phase two. When is phase two going to happen? And I guess he said that they're going to start right away. But it looks like this may not happen before the election.

I guess he was saying that he thinks he'll be in a better position after the election. Assuming, I guess, he's implying that he's going to win. And then, you know, being in second term, he'll be in a stronger position for phase two. So I guess we'll see. We'll see what happens there. You think China wants Trump to win the election? Probably not. But I guess I don't. Hopefully they won't interfere in the election like Russia, but I guess they probably rather not have him, I imagine.

Just it's probably not fun negotiating with him. We'll see. I guess that was the next actually topic on my list that is less important and it's still early days, but I was going to talk about the election. That's important. And it's still early days, but I was going to talk about the election. So it's still early days, I guess, but it's going to be on the radar of all the market participants. And I guess what's really key here is to understand who's going to be the Democratic candidate. So people following the Democratic primary.

And, you know, the polls. So Biden may lead in the national polls, but if the Democratic primary is a series of state elections and when you look at the polls in these states and if the state elections play out like the betting are suggesting at the moment, Sanders actually has a higher chance than it seems.

So investors are actually at the moment pricing 85% chance of Trump being reelected. The betting odds are showing something quite different. But the Democratic nomination odds are showing, you know, Biden at 40 and Sanders at 30. So it's early days for the election. But we may know in a month or two, like, if Sanders is the candidate or is likely to be the candidate. And if we have Sanders as a progressist with an agenda like Elizabeth Warren or Sanders, we are quite similar. And then again, I can refer you back to David's book on that. And again, I can refer you back to David's book on that.

Then I guess I think Margaret would be a bit more worried than if you have a more consensual candidate like Biden. So I guess we'll keep an eye on that. I guess the impeachment is probably not even worth mentioning it. I think it's, you know, it's more a show. I guess we don't really care so much looking at its distraction. I don't think anybody puts up expressing the chance of Trump being removed from office. So it's kind of irrelevant to at the moment. So we're not spending much time on that. And so, you know, I guess other than that, then it's really focusing on all the macro data that are, you know, released on a weekly, monthly,

quarterly basis, you know, the indicators that we care about. So, of course, it's the Fed meetings, and the next one will be at the end of the month, 20th, 28th of January. Probably not so much is going to happen at that one yet. The GDP announcement, the employment numbers, the retail sales announcement, the ISM numbers. So that's all the macro data that we follow.

And then moving on to the micro, we, I guess, just started the earning season. Not much has happened yet, but the first one to report typically are the investment, the banks. So we've seen the Wall Street banks already reporting with some mixed numbers. We only own one of them, and the one we own actually did well. So I guess we had the right name. By the end of the month, about 70% of our core dividend growers will have reported. So actually, it's going to happen in the next few weeks. We have four reporting next week, and then we have 16 reporting the last week of January.

So that's when we're going to get busy. It's also interesting to follow the bank's results because they give you, as well, some really good insight on the economy. You know, basically, they are global banks. They're everywhere, and they have a pretty good picture. So it was interesting to be on these calls and hear what they have to say. And I guess they can, you know, the feedback is quite, I would say, constructively

optimistic. They're saying that capital spending is still a bit soft, but sentiment is better than six months ago, basically. Business sentiment? Business sentiment, yeah. So, broadly speaking, they say they're constructive outlook for 2020. So, broadly speaking, they say the constructive outlook for 2020. So, you know, the thing that clearly six months ago,

probably at the same point, much when you had the peak of the trade war escalation, that's when business sentiment was hit, and now they see clearly it's getting better. That's interesting to follow these, to be on these calls, just to get the pulse, you know, hear what they have to say about the economy. Earnings season, just going to have that in the next few weeks.

It's also the dividend season, actually. You know, most companies pay dividend on a quarterly basis, and they decide the amount of the dividend at the board meeting, and usually, just the same time, they go through results or some strategic decision and they set the dividend for the next four quarters so the way it works usually most companies is they set the dividend and then they'll they'll pay on a quarterly basis for the next quarters and so usually it coincides with the financial year end so and most companies have

end of december financial year and that means that a lot of them are going to sit down now in january february go through annual results and set a dividend for the following 12 months so actually financial year. And that means that a lot of them are going to sit down now in January, February, go through annual results and sell a dividend for the following 12 months. So actually, you know, we're assuming based on, you know, what, on history that companies we own will announce a dividend increase, hopefully or not, but we hope by April. So this is the time of the year, basically, when these things happen. That's where we are. Market's all-time high. In terms of valuation, you will hear the market is expensive, 18.8 times PE.

I don't like to look at it on an absolute basis because it's expensive relative to what? I guess you have to see what is the alternative. And that's where we like, I'd rather look at risk premium because you can't compare 18 times PE when the 10 years at 1.8 percent against you know three percent where it used to be historically so if you look

at in terms of yield which is difference or the risk premium which is the difference the additional return you can make from owning equities against the instead of the you know 10 year u.s government loan it's at around 3.5%, which is actually more in line with historical averages. So on a relative basis, when you look at where bond trade and how much return you can make on bonds, actually equity markets are probably,

they're not cheap, that's clear, but they're not necessarily expensive. That's where, you know, and we're positioned with more defensive names. So we have a P on average that's lower than the market, a dividend that's higher. We have a beta that's defensive at around 0.85. And we overweight some sectors that we really believe in, like energy, financials, and staples. And underweight, some sectors that have seen some big moves that we think are expensive, like tech and consumer discretionary.

So we feel pretty good about how we're positioned going into 2020. that have seen some big moves that we think are expensive, like tech and consumer discretionary. So we feel pretty good about our position going into 2020. Yep, feeling good about it. And as far as the 18, 18.8 multiple in equities trading, some out there thinking equities are trading lofty. Like you said, it's so important to look at it not only on an absolute basis, but a relative basis. You can think of asset classes compete for capital and capital has to go somewhere, which is why it's so important to

understand that relative framework and what those other asset classes are offering. And when you look at that, equities don't look, as Julian was saying, equities don't look too bad. So that was interesting. So thank you for that rundown. What about as far as the earnings transcripts go? Was there anything that was surprising as far as the banks? I assume China was in there less maybe than last year? Yeah. I mean, I guess the banks, the one that did well, it was really they did very well on trading and fixed income trading in particular. That's right. The banks that didn't do too well, that's because they had some legal bills from issues. You could say it's almost like type of, you know, expenses.

So it doesn't necessarily mean that the business didn't do too well. It's just they had some exceptional legal, you know, bills that they, you know, liabilities that they took care of during that quarter. I guess the feedback, what they're seeing in the economy is like basically we turn the corner in terms of sentiment and things are getting better now than they were six months ago. Yeah, that's what it sounds like, especially on the business side. Yeah, consumer, even six months ago, I guess, they were saying consumer was great. So the question was more about the business confidence. And it looks like business confidence is coming back. Yeah.

So it's all good. Maybe we'll see those CapEx numbers increase, that CapEx data finally come through. The last week of this month is going to be a pretty busy one as far as earnings go.

So we'll have more, I guess, companies and so we'll have more chance to hear from them and be on this call and get more, you know, better sense of how they feel. And also this four

quarter is the most important because most of the announced four quarters, they also, some companies will only give one quarter ahead of guidance. But most of them will give you a full year ahead. So we're going to have guidance for the next 12 months. Awesome. Awesome.

And it's so important to look through those transcripts and understand that guidance. So thank you, Julian. So I think that about wraps it up. We gave you a bit of infrastructure, a good macro update. And I know it was only Julian and I, but next week we should have a bit more bodies and seats. Hopefully Robert, Brian, and David will be here next week, and it will be a pretty full investment committee and Dividend Cafe podcast. So hopefully some of that stuff was insightful. And that's about all we have for you. And we will see you next week. Sounds good. Thank you.

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