brian glaze & larry ware, crpc, cltc – proactive advisor magazine – volume 5 issue 4

January 29, 2015 | Volume 5 | Issue 4

Active investment management’s weekly magazine

Is “dollar parity” in the cards?

Why hasn’t the Efficient Market Hypothesis disappeared?

Selling proposition: “Plan-based investing”

Paul Desmond: Seasons of the stock market

Brian Glaze & Larry Ware

Evolution of partnership and practice

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Hostile, risky, and variable“All investors are interested in and need to maximize returns over a long period of time under variable and sometimes hostile economic environments. We find active investment management appropriate to meet this need, with strategies that can cross many asset classes, sectors and geographies. We use an algorithmic approach that is intended to perform under all market conditions and help manage what can often be a risky and hostile market environment. It is my belief that purely quantitative active money management has the best chance of deliveringthe intended result—maximizing the growth of the portfolio to increase the chance of meeting all future contingencies.”

LOUD & CLEARDavid Lademan • Lansing, MI Capital Strategies LLC • Kalos Capital Inc.

Advisor perspectives on active investment management

3 January 29, 2015 | proactiveadvisormagazine.com

LOUD & CLEAR

Dinosaurs: c. Triassic Period

VHS Tape: 1970-2000Rotary Phone: c. 1800-1900s

Efficient Market Hypothesis: 1960-?

Why hasn’t theEfficient Market Hypothesis

disappeared?By Linda Ferentchak

proactiveadvisormagazine.com | January 29, 20154

ne of the most fascinating constructs of invest-ment theory is the Efficient Market Hypothesis (EMH). It is widely taught in business schools, a required element of the Certified Financial

Analyst® knowledge base and Certified Financial Planner™ studies, and frequently quoted by journalists and financial experts. EMH is the foundation of the Capital Asset Pricing Model; the source of beta and the use of standard deviation in measuring risk, and the rationale for index funds.

And while it may well be the ultimate zombie of the investing world, study after study has shown the Efficient Market Hypothesis is inherently flawed.

continue on pg. 11

A market theory that evolved from a 1960s Ph.D. dissertation by Eugene Fama, the Efficient Market Hypothesis states that at any given time and in a liquid market, security prices fully reflect all available information. The EMH exists in various degrees: weak, semi-strong and strong, which addresses the inclusion of non-public information in market prices. This theory contends that since markets are efficient and current prices reflect all information, attempts to outperform the market are essentially a game of chance rather than one of skill.

The weak form of EMH assumes that current stock prices fully reflect all currently available security market information. It contends that past price and volume data have no relationship with the future direction of security prices. It concludes that excess returns cannot be achieved using technical analysis.

The semi-strong form of EMH assumes that current stock prices ad-just rapidly to the release of all new public information. It contends that security prices have factored in available market and non-market public information. It concludes that excess returns cannot be achieved using fundamental analysis.

The strong form of EMH assumes that current stock prices fully reflect all public and private information. It contends that market, non-market and inside information is all factored into security prices and that no one has monopolistic access to relevant information. It assumes a perfect market and concludes that excess returns are impossible to achieve consistently.

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The inherent inefficiency of “efficient markets” is well-documented, yet the theory persists.

Efficient Market Hypothesis

From the Morningstar Investing Glossary comes the following explanation

of the Efficient Market Hypothesis:

Index swings of 7% should occur every 300,000 years —yet the 20th century

had 48 such days.

For Professor Benoit B. Mandelbrot, known as the “father of fractals,” the failure of the EMH is a matter of mathematics. The hypothesis is founded on two critical assumptions—price changes are statistically independent and they are normally distributed. In “The (mis) Behavior of Markets,” co-authored by Mandelbrot and Richard L. Hudson, the authors debunk EMH by establishing that (1) price changes are not independent of each other—today does in fact influence tomorrow, evidenced in simple patterns, correlations, seasonal fluctuations of prices, and more—and (2) price changes are very far from following the bell curve. Under a normal distribution, market prices should cluster about the mean or average. The mathemat-ical reality of markets is that the far ends flare too high and there are too many pricing spikes (both to upside and downside) well outside of any normal distribution.

According to the EMH and its dependence on a normal distribution of prices, over the period from 1916 to 2003 there should have been 58 days when the market—rep-resented by the Dow Jones Industrial Average—moved more than 3.4%. There were 1,001 such days. The theory predicts six days of index swings beyond 4.5%—there were 366. One-day index swings of more than 7% should occur once every 300,000 years. In fact, the 20th century had 48

January 29, 2015 | proactiveadvisormagazine.com 5

Climbing U.S. dollar makes exports less competitive

hile the European Central Bank unveiled its bond-buying program last week, the euro was still in free fall, moving below most analysts’ forecasts to

end at its lowest point in more than 11 years. With a two-day slide of 3.5% after the ECB announcement, the euro has now lost over 7% on the year and calls are growing louder that “dollar parity” could be in the cards.

ECB President Mario Draghi statement—that the central bank will buy 60 billion euros ($69 billion) of public- and private-sector debt every month through September 2016—left the door open for more easing. MarketWatch says the injection of cash into the Eurozone’s financial system is expected to contribute to higher inflation and economic growth.

For perspective on the euro’s steep decline, the currency traded at an all-time high of around $1.60 versus the dollar in 2008 and was trading close to $1.40 as recently as May, 2014. The recent move below $1.20 has many analysts predicting levels under $1.10 by 2015 year-end and few will be surprised if the parity level is reached in the next two years.

According to The Wall Street Journal, Europe’s new program of money printing and Japan’s “Abenomics”—and the resulting steep losses for both of their currencies—means the U.S. economy must deal with a rapidly strengthening dollar that will make American goods more expensive abroad.

W

Source: The Wall Street Journal

The ECB’s asset-purchase program aligns the Eurozone’s monetary policy more closely with Japan’s expansionary policies, while the U.S. Fed has closed down its large-scale asset purchase program and is moving closer toward raising interest rates. The resulting impact of the dollar rise will be felt heavily by both U.S. manufacturers and others with global exposure.

FactSet’s most recent Q4 earnings analysis noted, “A number of companies have commented on the negative impact of the stronger dollar on revenue and earnings for the fourth quarter and in guidance for future quarters.” Companies including Monsanto, ConAgra, Oracle, Accenture and General Mills have all said, in effect, “We do see currency moves as a continued headwind.”

EURO AND YEN DECLINE RELATIVE TO EXPORT DATA


TOPPING THE CHARTS

Proactive Advisor Magazine: Thank you both for joining me today. How did you come to form your partnership?

Larry Ware: Brian and I have known each other for many years through a relationship that started when we both worked for Southeast Regional Bank broker-dealer. I covered a regional area as an investment consultant and Brian was working as a licensed banker at one of the branches. We found over time that we worked exceptionally well together and shared a common philosophy on client service and how to approach the investment process.

Brian Glaze: Larry deserves a lot of credit as the mentor in the relationship regarding investment services. My responsibilities and role over the years at the bank evolved into handling client investments, but I pretty much had a soup-to-nuts exposure to all aspects of retail

Brian Glaze & Larry Ware

EVOLUTION of partnership & practice

Business partners embrace the evolving technology and best practices that make the most sophisticated money management strategies available to their clients.

By David WismerPhotography by Renee Saunders


continue on pg. 10

that the spouse be involved, at least in the initial and final phases. And though it is a very extensive exercise, we try and simplify things by identifying the top three to four financial planning priorities for that individual or family—whether it is col-lege planning, debt reduction, legacy planning, or overall retirement goals. Within those priorities, we then identify the framework around the key issues of the investment time frame, the specific taxation situation, and appropriate risk level.

Brian: Once those overall parameters are set, we can get into a fuller examination of appro-priate asset allocation buckets and investment alternatives. We have become strong advocates of an active money management approach for the investment side of the ledger. That means several things: making sure that risk is managed first, not worrying about market predictions or investment biases, and developing portfolio alternatives with the potential to perform well in either up or down markets. And, though various strategies might be very sophisticated and quantitatively based, we believe in keeping our education and explanations for clients at an easy-to-digest level.

knows this on a gut level, it is something else to see it laid out. Few clients are aware of the fact that while equity markets have historically risen 59% of the time, for the other 41% they are either in a sideways or bear market.1

We then use that information as a spring-board to ask the question, “Why would you want to invest using strategies that are likely not going to work almost half of the time?” This leads nicely into a discussion of the benefits of actively managed strategies versus a buy-and-hold approach.

Larry: Right. One of the primary benefits of active money management is the potential to

1Reported by a market study conducted by Flexible Plan Investments Ltd. Research Department on the S&P 500 Index from 1953 to 2012.

banking. I think understanding the ins and outs of the loan process, insurance products, and a variety of other banking services is a valuable additional perspective I can bring to the client planning process.

How would you describe your shared client philosophy when it comes to client investments?

Brian: We had a lot of success in our partner-ship at the bank and were recognized as one of the top producing teams. When we left, we were re-sponsible for about 1200 client relationships and about $100 million in client accounts. We both believe in superior service and being extremely attentive to client needs. At times this might involve a fair amount of client hand-holding, but I prefer to think that we minimize that by being very upfront with clients as to investment expectations. One of the most important things in this business is clearly explaining alternatives to clients and outlining the accompanying risks and potential rewards. Having this shared set of expectations from the beginning of the relation-ship helps defuse issues down the road and has contributed greatly to our success.

Larry: Brian mentioned the number of cli-ents we had and that was very gratifying. But it was also one of the reasons we decided to form our own advisory partnership. We wanted to provide more in-depth relationships with our clients throughout the financial planning and implementation process, which is difficult to achieve with that many relationships.

We are dedicated to developing a highly personalized planning process that can cover just about any aspect of a client’s financial life. There is really one key concept that describes what we most believe in as an investment philosophy: protect and grow client assets while minimizing risk.

Let’s talk about that core concept—how do you go about pursuing that?

Larry: Most importantly we go through a full discovery and financial planning process with cli-ents over several meetings. It is definitely preferable

One key concept describes what we most believe in as an investment philosophy: protect and grow client assets while minimizing risk.

These strategies have the ability of going to cash, going long or short an asset class, and to rotating through various allocation or weighting scenarios

dependent on market conditions.

How do you explain an actively managed approach to clients?

Larry: It begins with a discussion of risk and their specific risk profile. We use the suitability questionnaires of our third-party money man-agers and specific software that helps quantify their risk profile.

Brian: Our money managers provide excel-lent educational materials for clients. We look at things like the cycle of the S&P 500 over a 20-year timeframe and show clients the reality of the volatile swings it has experienced. Though anyone who has been in the market certainly

Larry Ware


Show your clients a

friendlier

bear market

800-347-3539 | f lexibleplan.com

Past performance does not guarantee future results.

The opportunity for profits

carries with it the possibility of losses.

800-347-3539 | flexibleplan.com

A complete list of all of our recommendations over the last 12 months and Brochure Form ADV Part 2A are available upon request.

L E A R N M O R E

Larry Ware and Joseph Brian Glaze offer Securities and Advisory Services through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.

No strategy assures success or guarantees against loss. Investing in securities is subject to risk and may involve loss of principal. Active money management may involve more frequent buying and selling of assets and will tend to general higher transaction costs. Investors should consider the tax consequences of moving positions more frequently. Asset allocation does not ensure a profit or protect against a loss. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Alternative investments and leveraged strategies may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments and leveraged investments may accelerate the velocity of potential losses.

continued from pg. 9Ware & Glaze

avoid or minimize those large losses that come with severe bear markets. We also like the abil-ity of selecting among a wide range of equity, bond, and alternative investment strategies. These can be used in a great variety of combi-nations, dependent on the client’s risk profile and objectives for that specific investment allocation. These strategies have the ability of going to cash, going long or short an asset class, and to rotate through various allocation or weighting scenarios dependent on market conditions. We feel this is a much stronger and proactive approach to today’s investment envi-ronment. Returns may not be as great during bull markets, but the overall approach aims to work well over the long term and has the ability to smooth out returns. And for the aggressive investor, there are several strategies available that may use leverage, if that meets their specif-ic objectives for some portion of their portfolio.

How has active money management been beneficial to your practice?

Brian: Active money management has fundamentally changed our approach to marketing our practice, how we talk to clients about their investment alternatives, and our core story. We explain to clients how this is a step beyond Modern Portfolio Theory or classic asset allocation and is really one of the most sophisticated types of money management out there for managing risk. Clients know that they have full-time money managers monitoring the markets, technical signals, and trend changes. Our job is to find the best money managers and then manage the managers.

Larry: We can confidently tell clients that we think active management will serve them well over full market cycles. Many clients have lived through at least one, and maybe

up to three, extreme roller coaster roundtrips in the market. Active management gives us the opportunity to address head on what we feel is most important to our clients for their investment portfolios: providing for compet-itive returns, managing risk, and minimizing portfolio drawdowns.

Brian Glaze

10 proactiveadvisormagazine.com | January 29, 2015

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such days. That level of inaccuracy should be inacceptable in any widely accepted theorem. Mandelbrot proposes that instead of looking to the bell curve as a model of market probabilities, fractal mathematics may create a better fit.

James Montier, the global specialist member of GMO’s Asset Allocation team, maintains that the elephant in the room for the EMH is the existence of market bubbles. Montier is the author of several books including “Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance,” “Value Investing: Tools and Techniques for Intelligent Investment,” and “The Little Book of Behavioural Investing.”

The EMH’s dependence on the bell curve as a means of assessing market risk predicts that market bubbles, defined by GMO as two stan-dard deviation events, should occur roughly once every 44 years. GMO’s data analysis shows 30-plus bubbles since 1925—slightly more than one every three years, explains Montier.

According to Yale professor and 2013 Nobel Prize recipient Robert Shiller, the EMH overlooks the importance of social psychology in financial markets, “one of the most remarkable errors in the history of economic thought.” In this, Shiller echoes the belief of Mandelbrot who maintains that markets have a personality—prices are determined by the actions of investors, speculators, industrialists and banks coming together at a specific time and public mood.

The EMH is fairly definitive as to what it takes to outperform the market—either inside information that is not available in the pricing

continued from pg. 5

continue on pg. 13

Disappeared

What did we learn about bonds in 2014?After a less-than-stellar 2013 for bonds, many investors were ready to turn their backs on the asset class. But many didn’t and were rewarded for their long-term perspective.

Build trust with clients through clear communication and transparencyIf you can’t clearly communicate your value and strategies, your clients and prospects are unlikely to want to do business with you on all-important financial matters.

High-net-worth millennials more likely to keep advisorsThe wealthier millennials are, the less likely they are to leave their parents’ advisors, according to new research from TD Ameritrade.

L NKS WEEK


The seasons of the stock market

Paul Desmond is the President of Lowry Research Corporation, the oldest continuously published advisory firm in the U.S., founded in 1938. He also serves as Chairman of Lowry Capital Management Corporation, was a past president of the Market Technicians Association (MTA) and a founder of the American Association of Professional Technical Analysts (AAPTA). Mr. Desmond and Lowry Research are the recipients of numerous awards for excellence in technical analysis. www.lowryresearch.com

he primary trend of the stock market has always been described as either a bull or bear market: one or the other. But, life is rarely so simple. It could be effectively argued that, just as

there are four seasons to the year, there are four seasons to the stock market.

The spring of the year is born from the ravages of winter. The spring of the stock market is born of the ravages of a bear market. During the spring of the year, new green life seems to explode from hibernating seeds. Everything grows at a rate never to be seen again for the rest of the year. In the spring of a new bull market, almost every stock goes up, with the biggest gains made by the small-cap and low-priced stocks. The slowest growing plants in spring are mighty oaks, and the slowest advancing stocks in a new bull market are usually large-cap blue chips.

To capitalize on the opportunities available during the spring of the stock market, it is important to get fully invested as soon as possible after a new bull market begins. That probably means finding a money manager who has a documented record of accurately identifying the start of new bull markets. When the time comes, 65% might be invested in small-caps and 35% in mid-caps. Note that this is in direct conflict with the experts who call for “averaging in”, or being half long and half short, or always buying large-caps.

During the summer of the year, plant growth continues, but at a slower pace. A few plants die from the hot sun, or a lack of water. For the most part, it is too late for major new planting. During the summer of the stock market, large-cap stocks start to join the leadership. This usually calls for a shift in portfolio holdings to say, 40% small-caps, 35% mid-caps and

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25% large-caps. But in the summer, investors must step up their alertness, since some stocks become overpriced, or lose sponsorship, and languish. These stocks have to be culled from the portfolio, just as weeds need to be pulled.

In the autumn of the year, the leaves begin to change color, and eventually fall from the trees, one by one. Crops begin to reach full maturity and must be harvested, or they will rot. In the autumn of the stock market, the leadership shifts decidedly to the big-caps, as many small-caps and mid-caps become overpriced and begin to roll over, one by one, into their own bear markets. This requires further realignment of portfolios, moving away from small-caps and mid-caps, and focusing primarily on large-caps for the remaining months of the bull market. As individual stocks fail to rise to new highs with the S&P 500 Index, they must be

eliminated, constantly reducing holdings in preparation for the inevitable bear market.

We are now in the autumn of the current bull market. About 44% of small-cap stocks have already dropped 20% or more from their highs and the current leadership is heavily focused in large-cap stocks. More and more small-cap and mid-cap stocks are rolling over, one by one, into their own bear markets, while the large-cap S&P 500 Index should continue to reach new highs for at least several more months.

Just as the autumn of the year is a constant warning of the approach of winter, the autumn of the stock market is warning that investors should be harvesting fully-ripe stocks to avoid the ravages of the next gradually approaching bear market.

Proactive Advisor Magazine presents weekly commentary provided by well-known market analysts, financial authors, investment newsletter publishers, and economists. The opinions expressed each week represent their personal perspectives and not necessarily those of the magazine.


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continued from pg. 11

of stocks or the ability to forecast the future better than everyone else. Under the EMH, fundamental and technical analysis, which each rely on available information, should not offer the investor any advantage. This leaves suc-cessful investors such as Warren Buffett, Peter Lynch, Jim Rogers, John Templeton, Benjamin Graham and other legends in the industry as either consistently defying impossible odds or clairvoyant. The ability of accomplished in-vestors to outperform the market over lengthy periods should not occur in efficient markets.

In support of the EMH, its defenders typi-cally point to the failure of active managers in general (typically referring to stock pickers) to outperform the market. But detractors of the hypothesis point to the proliferation of bench-marks, style boxes and betas, and industry stan-dards which reward managers not for beating the market, but for playing it safe and mirroring market performance. The more traditionally diversified the portfolio, the more likely it is to reflect the overall market, less management fees.

In contrast, a recent study of portfolio

managers’ select “best ideas” found these investments able to outperform the market. Investment banks and other portfolio managers employ thousands of analysts and traders—as well as an array of sophisticated models—in what should be a completely futile effort under the tenets of the EMH. But perhaps that is not so futile, as the success of many different varia-tions of actively managed portfolio approaches has been well-established over the past 30 years.

Which brings the subject back to the ini-tial question: why does the Efficient Market Hypothesis continue to dominate investment philosophy? James Montier may have summa-rized the reason best in a recent presentation:

“Academic theories are notoriously subject to path dependence (or hysteresis, if you prefer). Once a theory has been adopted it takes an enormous amount of effort to dislo-cate it. As Max Planck said, ‘Science advances one funeral at a time’.”

Perhaps the greatest tragedy of the Efficient Market Hypothesis is the effect it has had on corporate governance. The EMH rewards short-term performance and the creation of “shareholder value.” Companies are no longer valued for long-term growth prospects but primarily on the immediate information avail-able to the markets. Perversely, the growing influence of index investing minimizes the im-portance of even short-term returns, replacing performance with demand for the index as an important driver of stock prices. The Efficient Market Hypothesis has changed the investment world, but arguably not for the better.

Disappeared

Linda Ferentchak is the president of Financial Communications Associates Inc. Ms. Ferentchak has worked in financial industry communications since 1979 and has an extensive background in investment and money manage-ment philosophies and strategies.

The Efficient Market Hypothesis has changed the investment world, but arguably not for

the better.


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Copyright 2015 © Dynamic Performance Publishing, Inc. All rights reserved. Reproduction of printed form, whole or in part, without permission is prohibited.

EditorDavid Wismer

Associate EditorElizabeth Whitley

Contributing WritersPaul Desmond

Linda FerentchakDavid Wismer

Graphic DesignerTravis Bramble

Contributing PhotographerRenee Saunders

January 29, 2015Volume 5 | Issue 4

Proactive Advisor Magazine is dedicated to promoting and educating on active investment management. Distribution reaches a wide audience of financial professionals who advise clients on investments and portfolio management. Each issue features an experienced investment advisor who offers insights on active money management, client service, and investment approaches. Additionally, Proactive Advisor Magazine offers an up-close look at a topic with current relevance to the field of active management.

The opinions and forecasts expressed herein are those of the author and may not actually come to pass. Any opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. The analysis and information in this edition and on our website is for informational purposes only. No part of the material presented in this edition or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any portfolio constitutes a solicitation to purchase or sell securities or any investment program.

Selling proposition: “Plan-based investing”

Jerry Ganz, CFPGreen Bay, WI

Packerland Brokerage Services Inc.Jerry Ganz Financial Planning

Securities and advisory services offered through Packerland Brokerage Services Inc., an unaffiliated entity. Member FINRA & SIPC.

One of the more consistently effective questions we ask is whether or not some-one truly has a financial plan for the future. They may think they do before reading the book, based on their relationships with in-surance agents, bankers, or brokers.

We can confidently show them how that is usually a piecemeal approach, and does not outline real goals and objectives to measure against. That is a compelling message to prospects.”

ur firm primarily markets to prospects within five years of either side of re-tirement. That really seems

to be the sweet spot for those attracted to our marketing efforts, as they have finally reached a point in life where they are open to hearing about a long-term solution to their retirement needs.

I firmly believe that a practice has to have a unique selling proposition. Ours is based on two core concepts. The first (and I have actually written a book about it) is the idea of plan-based investing. The second is our firm’s use of third-party, active invest-ment managers.

While I find there may be a place for many different strategies for clients, I be-lieve in strong risk management and strat-egies that can be tactical or rotational and that adapt to market conditions. I don’t really know of any other financial advisor in our area who combines these principles the way that we do.

The book is titled—no surprise—“Plan-Based Investing.” While it is a pretty easy read, we think it packs a lot of worthwhile information in a short space for prospects, current clients, and anyone else interested in the issue of how a financial plan should inform investment strategies.

We conduct a sophisticated and regular system of mailings to prospects, with this book at the center of our efforts. We also have press releases for local and national media, a website, and I have personally had a number of book signings.

We have found that the book raises some provocative issues for people. They want to learn more and see how some of the principles we speak of may apply to their situation.

O“

14

TIPS & TOOLS

brian glaze & larry ware, crpc, cltc – proactive advisor magazine – volume 5 issue 4

Economy & Finance