Today, investors and their advisors run a very big risk. An increase in bond rates could cut a big hole in their plans as, portfolio values fall, clients get angry and advisors make excuses. And this time, it’s not a stock market decline that will trigger it, but a modest increase in bond yields, primarily U.S. Treasuries, the benchmark around which most bond asset classes are priced. For years, pundits have warned that government policies which ballooned our national debt, would stock inflation a la the late 1970′s. That is supposedly the prevailing worry for bond investors, since a ratcheting of rates higher by the Fed and other central banks from historically low levels could prompt fear and panic in the bond market, as bond prices plunge. We are not trying to predict if or when that will happen. We prefer not to predict financial catastrophes (there is an entire sub-industry which devotes itself to that). Instead, we prefer to size up the possibilities and act with conviction when that is required.

It doesn’t have to be this way. To explain why we think so let’s use an analogy from the world of America’s Pastime, baseball. After all, the World Series starts next week.

In baseball a “5-Tool Player” is one who has high-level abilities in these areas: hitting for power, hitting for average, running, fielding and throwing. 5-Tool Players are a special breed, and teams covet them.

At Sungarden, we have identified 5 tools we think a premier investment approach should have in order to be successful in our arena, the achievement of client goals and growth of advisory practices:

  1. Preserve Capital by actively defending against big losses
  2. Produce Income that is sufficient, stable and growing
  3. Grow over the Long-Term
  4. Reasonable total cost (this may not be the cheapest alternative available, but the one that has the best tradeoff with the potential merits of the investment)
  5. Liquidity that is intraday or daily

When we look at traditional approaches to Income and Preservation of Capital, we find some with 2 or 3 tools…but none with 5 or even 4. This is our opinion, and can be debated, but in our many years in the industry, we have seen them all and these are our conclusions.When looking at Growth approaches, the same pattern appears – 2 or 3 tools, not 5 or even 4

We also looked at so-called “Hybrid” investing approaches, such as allocation funds, hedge fund and alternative mutual funds. The conclusion: ditto, no 5-Tool approaches or even 4.

Our conclusion is that we need to take the best of some of these approaches and create a portfolio structure that stands a better chance of delivering on the 5-Tool idea.

Here is an introduction to what I consider to be a 5-Tool Portfolio approach:

  1. Preserve – we prioritize hedging against major losses. We use inverse ETFs but can employ protective options as well, if required.
  2. Produce Income – dividends that are sufficient for client needs, stable and growing offer a great alternative to bond interest from a washed out bond market. After all, while governments and consumers are still limping from the 5 year old banking crisis, many corporations managed well and thus have a lot of cash. Maintaining their dividend payouts is one use of that cash. Another could be raising the dividend.
  3. Long-Term Growth – we have identified 10 long-term themes we consider to be undeniable, and they form the focus of our investment approach. We can discuss these with you in more depth off-line.
  4. Total Cost – our industry is obsessed with finding low-cost mutual funds and ETFs. But think about it: what is the expense ratio of an individual stock? ZERO. Want to impress your clients with how low you can make the cost of your offering? Use individual stocks as the core of their portfolio.
  5. Liquidity – stocks trade intraday, ETFs do as well. Mutual funds offer next-day liquidity. That’s as far as most investment approaches need to go, in our opinion.

Effectively, this can be broken down to a solution which is the marriage of Equity-Income and Long-Short investing. While I lead a team that practices this approach for the majority of our private client assets , I am astonished that we cannot find others who approach portfolio management in this way. That is why we started to offer our “Cash Flow Focused” approach to other financial advisors.

5-Tool Players are tough to find in the Major Leagues. They are even tougher to find in the portfolio management realm. But if advisors are to get serious about addressing the realities of investing in 2013 and beyond, they had better get start updating their toolbox or find someone who can help them do so.

© Sungarden Investment Research

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