The Dividend Cafe - The Magnify Moment in COVID

Episode Date: October 23, 2020

There are a couple things going on right now at The Bahnsen Group that make this a very fun time of year, and a very fun edition of the Dividend Cafe. I wrote last week about the annual money manager due diligence trip I have done since 2006 and how important it is to our business (and to our clients). The meetings of the last couple weeks, this year, coincide with the launch of our “Operation Magnify,” the largest portfolio undertaking we have ever experienced at our firm. So today’s Dividend Cafe takes the reasons Operation Magnify became necessary, juxtaposes it with this COVID moment (what it supposedly means, what it most definitely does not mean, and what some think it may mean), and then applies lessons learned from our recent meetings and collaborations. I am aware the world is mostly focused on the election event coming up a week from Tuesday, November 3. There very well could be ample uncertainty and market volatility that comes as a result of the election (or the non-result). It would be difficult for me to devote much more attention to that subject than I have. But the topics I want to dive into today are leaps and bounds more relevant to investors, long-term, than whatever uncertainty volatility the election results create. And like many understandings of the connection between politics and our portfolios, I believe the topics I am addressing today are riddled with misunderstanding. “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” (wrongly attributed to Mark Twain). Let’s jump into the Dividend Cafe! Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello and welcome to this week's Dividend Cafe. This is David Bonson. I'm the managing partner and the chief investment officer at the Bonson Group. And I am just absolutely thrilled to be here in Newport Beach at our company headquarters, bringing you this week's Dividend Cafe on the very special subject of our Operation Magnify in the COVID moment and juxtaposed with these money manager meetings we've had over the last couple of weeks

that I spoke at great length about last week. Last week's Dividend Cafe was focused around the kind of historical context of these different meetings and what it has meant over the years, not only to me personally, to our business and to our portfolio management process. And this week, I want to talk a little bit more about these two things that have come together at this time that have really just been a massive endeavor here at our company. And I will tell you in advance, whether you're watching the video or listening to the podcast, I say it all the time. And usually I'm saying it because I want you to see the charts that we put in the Written Dividend Cafe. And I don't think I have

a single chart this week other than the chart of the week, because we always do that. But I am going to say that I believe there's a 0% chance I will capture everything here in this podcast the way that I think I've captured it in written form. And so all that to say, if you have a chance to check out DividendCafe.com and kind of read over the written summary, I do believe it's a readable and digestible walkthrough what we mean by Operation Magnify. And I'm going to walk you through some things right now, and we're going to end up talking about COVID, and we're going to talk about the economy

and what it means at this point in time. And I hope you will come away from this with a little more optimism and a little more realism about where things stand. To magnify the principles that we've always believed in and realign client portfolios around a new structure that we've created, a structure that is new but that is rooted in principles that are not new. Magnifying our belief about the basic laws of economics. And this is something I spent a lot of time in the written Dividend Cafe this week talking about. and this is something I spent a lot of time in the written dividend cafe this week talking about. I don't want anyone to get the impression from all of the talking and all the writing I'm doing about the changes in bond market expectations because of a 0% interest rate that I believe impact ends there. The impact starts there. It's mathematical that when a treasury bond is yielding seven one-hundredths of one percent, that interest rates going down is very unlikely,

very unlikely, and that you have essentially a no return asset class. Okay. That's a mathematical statement. And that there is an impact to that now, unlike post-financial crisis, that it is true up and down the term structure. 30-year bonds are barely yielding anything and 10-year bonds are yielding well less than 1%. And 5-year bonds, 2-year bonds, 90-day bonds are yielding basically zero. So that has an impact into the expectations of treasury bonds and has an impact in the expectations of municipal bonds and high-grade corporate bonds, but it also has an impact to the expectations

of equities. It takes away a risk mitigation tool for central bankers to try to cushion markets in the future. It reprices equities when their cash flows of companies, their earnings of companies are being discounted against a 0% risk-free rate. It encourages more borrowing that has an impact into credit and has an impact into private equity. The price of money, I don't ever want to give you the impression that it is anything other than the very first thing that matters about everything in finance, in portfolio investing, and therefore in financial planning and in the real practical side of wealth management that we do. And so I do kind of vent a little in Diving Cafe this week about my frustration with those that hold themselves out as financial advisors that are agnostic about this topic or don't understand it or don't get it or

don't talk about it or don't address it or don't apply it. I know so many financial advisors that I already know the reason why they don't, but I don't need to be mean and I don't need to be accusatory and I don't mean to be specific and I don't need to be accusatory and I don't mean to be specific. I'm just telling you in a very general sense that you deserve to have this basic law of economics at the foundation of how a portfolio is understood, evaluated, looked at, how expectations for cash flow, for risk, for return, for long-term goals are all understood around the price of money, the price of credit, the very, very first step. And I think that that's an important part of what this whole magnify process is about.

But see, this isn't a pejorative comment about the asset class that we call boring bonds, because I believe, and we've already seen it as we're going through this on behalf of clients, I believe there's clients that are going to right now come out of this campaign with a higher allocation to boring bonds than they had before. And there's a lot that are going to come out with no allocation because it really is different client by client. As I've already said, so I'll try not to restate it, but more or less boring bonds still have one of the benefits that they've always had, which is capital preservation, but they've lost two other benefits they used to have, which is some kind of positive carry in cashflow, three, four, 5% yields are gone. They're now zero to one. And they've lost severe risk mitigation through

distress moments. Those are two big things that are gone. But one is still there. And that one matters, capital preservation. And so that has to kind of be a driving conversation about one's understanding of risk and then therefore return. If you were expecting to get 4% from 25% of your portfolio and now you're expecting to get 1%, you have to then decide if you want to make it a different weighting in your portfolio. And if you don't, what that means to your return expectation, where you need to put on more risk elsewhere or where you need to replace that risk. That led then naturally to a conversation of alternatives and where we may want to have a replacement to some of the realities taking place within the fixed income spectrum and yet not necessarily increase equity beta and where alternatives could fit in there. And then for a select amount of clients where illiquid alternatives could become a very viable option for certain clients and

investors. And then the magnification around equity exposure where core dividend always and forever sits as the basic core building block of a client portfolio at the Bonson Group and our never-ending belief in the power of operating enterprises that are growing the free cash flow they're paying to investors and the incredible benefits that offers

to accumulators and withdrawers alike. All the while, we then enhance some characteristics, either growth through what we call growth enhancement strategies that include small cap, include innovation and technology, and then emerging markets. That could be very appropriate for some clients. It could be very inappropriate for others, but we want to separate it, differentiate it, identify it, and evaluate what it represents into the return and risk profile of a client portfolio. And then on the other hand, income enhancement, where clients who don't need cash flow from their portfolio at all probably don't

want any such thing, but clients that have a sort of high withdrawal need as a function of math out of their portfolio, the income generating capacity of their portfolio by its denominator, where they want a little superlative charge of cash flow generation, things we can do to help supercharge that process. flow generation, things we can do to help supercharge that process. So you have your boring bonds, you have credit. We will have to separate those things for reasons I've already talked about in the past and I'll skip it now. The core dividend is the basic foundation. Then we enhance with growth enhancements, enhance with income enhancements and have alternatives there, both of the illiquid and more traditional understanding of alternatives to round out a client portfolio. Well, at the end of the day, this whole process has been very healthy around the zero interest rate environment, around a re-analysis of one's own tolerance for risk, volatility, especially out of the truly difficult moments earlier in the year.

And I believe that we now sit and wonder where the economy goes, where the market goes. And this COVID moment now that I think is such an incredible opportunity for people to get things wrong about the future. And I don't mean the future like November 4th, the day after the election. And I don't mean future like people predicting if it's Q4 or Q2 when a vaccine comes. I'm not going through the whole COVID thing right now, although I do actually write a little bit about it in Dividend Cafe. But my point is not to predict when a vaccine comes and what policymakers are going to do or should do. I kind of have written plenty about all that stuff. My point is that this notion that COVID has proven to be a big disruptor, I think is totally wrong. And what I don't mean by that is that it hasn't been disruptive to the life and health of our society, where people have lost loved ones, where people have

been really tragically sick and had extended need for medical care, not to mention even apart from the medical aspect of COVID, but the economic impact it's had to people who've lost jobs and things. Okay, well, there's a total disruptive reality to all that. I mean, the long-term economic impact has been an accelerator, not a disruptor. This is a very key theme that I'm looking for application on right now that I found some kindred spirits in some of our portfolio manager meetings as we discussed this. portfolio manager meetings as we discussed this. Food delivery was growing rapidly before COVID, and it went parabolic during the shutdown. And so as I look through right now, I'm looking at my list of things that I used to illustrate this point in Dividend Cafe this week. The trends of younger people buying single family homes in suburbia, that was going on pre-COVID. It's picked up. The Sunbelt was the nation's hottest real estate market before COVID.

It's now gotten even hotter, and I don't mean that in a weather way. Interest rates were very, very low before COVID. They're now at zero. San Francisco was falling apart before COVID. It now seems to face an existential crisis. Cisco was falling apart before COVID. It now seems to face an existential crisis. Tech companies were becoming the big tenants in New York City office real estate, and that has picked up even as finance companies question what their long-term office needs will be.

States that had troubled finances before COVID have more troubled finances now. Brick and mortar was handing over market share year by year by year to e-commerce for over 20 years. That picked up a couple of years worth of pace just in a couple of months. I can go on and on and on. But that's really the story of COVID economically, macroeconomically. It accelerated trends. It didn't reverse trends, didn't disrupt trends that way. And so please hear that headline. COVID is not a disruptor.

It's an accelerator in the right context. I'm well aware of the tragic disruption represented, but I speak to this sort of economic reality. I think what a lot of people mean about the COVID changes are not the acceleration of trends that were in place when they seek to apply this economically. But I think that there is a real risk of people believing. And again, I don't know what some governors or mayors or future presidents will or won't do. The policy side is obviously very unpredictable. I speak more to the human spirit here. I speak more to the reality, the great historical reality of human action. Speak more to the reality, the great historical reality of human action.

If one believes in their investment thesis that entrepreneurs have lost their ability to innovate, they believe something totally incompatible with the way I'm going to manage your money. If one believes that humans have lost a craving and indeed a need for community, they believe something that is going to prove so tragically wrong. I can't even fathom how they might seek to invest around that thesis. Yes, restaurants, travel, leisure, hospitality, very affected right now in a lot of profound ways, much less affected than many had feared, by the way,

but nevertheless, awful data across the board. Do I think there's going to be pent-up demand in that space? I know it. I'm confident because of what I know about human action, unquenchable thirst people have for a vacation, for a weekend away, for dinner with their family. The re-engagement of norms and activities in our society that have been taken away by the COVID moment is not gone away. It has been put to the side and it is right

now building up a pent-up demand. And it is my belief that the things that have been most affected negatively by COVID will be the things that are most positively impacted on the other side because that pent-up demand will come out and hit us like a tsunami and I can't wait. So as we look to the COVID moment, look to magnify principles in our portfolio, we have to deal with the economic realities of government indebtedness, of low interest rates, of risk reward in a portfolio. We have to avoid big mistakes of people believing things as stupid as that Central Park will never come back. It already has, by the way. That entrepreneurs won't be able to figure out

how to go start new businesses, replace old ones, fix current ones, all that kind of stuff. And we have to be able to view things with a longer-term perspective, not just focused on certainly market real moments along the way, but magnify the principles that have mattered long-term in our portfolio so as to meet the financial goals that we have. That's all I have for you this week in the Dividend Cafe. Please do read DividendCafe.com if you have the for you this week in the Dividend Cafe. Please do read

DividendCafe.com if you have the time. Please reach out to us with any questions. I can elaborate on this stuff at great length. Truly appreciate you listening to the podcast, watching the video, and look forward to coming to you again next week with more at the Dividend Cafe. Thank you. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

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