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“It is difficult to make predictions, especially about the future…”
By George Gay

Occasionally, an internal e-mail “conversation” is worth summarizing and sharing widely—as a way to illustrate the deep thinking that goes on behind the scenes at First Affirmative and the value proposition that is central to our purpose as an asset manager and consultant to socially conscious investors.

Recently, a network advisor brought Harry Dent’s new book, “The Demographic Cliff,” to the attention of the Investment Committee. Dent predicts that the shrinking Boomer middle class will drive down consumption and demand for basic residential real estate, causing a deflationary fall in the prices of stocks, real estate, and a wide variety of goods and services. His reading of the tea leaves (aka economic data) conveys the sense that all of the stimulus that has pumped up the economy and the markets over the past few years will actually have a deflationary effect longer term. He predicts the beginning of a drastic downturn during “early 2014”—in other words, any day now.

This stimulus inspired a reiteration of the role First Affirmative plays with network advisors and clients—which is to design asset allocations for various risk levels using primarily SRI investment strategies (mutual funds, ETFs, managers). In our investment process, the network advisor has the primary responsibility to discuss risk with the client, and to choose and/or recommend an asset allocation consistent with the risk tolerance and risk capacity of the client.

First Affirmative currently works with 24 Model Folio managers and a comparable number of Mutual Fund management companies. While some simply try to minimize tracking error against certain benchmarks, others work to generate alpha (which is portfolio-speak for returns in excess of a target benchmark). It’s fair to say that all of these well-trained professionals have a responsibility to evaluate economic trends, demographic data, and various other trends affecting companies and markets. With each firm making its best judgments of what to do based on their assessments of the risks and opportunities of the future, we believe that each level of risk-targeted asset allocations will perform in an acceptable way.

Since the last time First Affirmative had an extensive discussion on this topic, we have developed and implemented more capability than ever before to allow an advisor to craft recommendations with the goal of mitigating market risk. Such capabilities include the opportunity to allocate 15% or 30% of a client’s managed mutual fund portfolio to “alternatives” (products designed to either reduce risk or otherwise perform differently than stocks and bonds), and the addition of various “tactical” options to the manager lineup inside of our Unified Managed Account program.

The Investment Committee discusses and evaluates economic trends, which informs the decisions we make in certain areas, such as fixed income duration (sensitivity to changes in interest rates) and manager selection. We do not have the desire or the ability to do active tactical asset allocation at a client account level ourselves, and we do not anticipate that we will attempt to offer this service at any point in the near future, although we will continue to evaluate mutual funds or model managers who show promise in this area.

In fact, we have strong reservations about the ability of anyone to predict the future accurately and, more importantly, to predict accurately what will happen in the markets even if the macro predictions do play out. At a very simplistic level, just in 2014, the highly anticipated “Great Rotation” from bonds into stocks has not occurred, nor has the anticipated rise in interest rates. We remain constantly aware of the adage that “the markets can remain irrational longer than you can remain solvent.”

There are certain predictions upon which all (at least most of us) can agree…

  • Baby Boomers will continue to get older. In fact, everyone alive gets older every day.  But, everyone alive will also have an increasing life expectancy; thus, the percentage of the elderly will increase as a share of the total population.
  • There are more Millennials than there are Boomers. At some point, this will matter.
  • Most Boomers will work longer than most people expect, partly because they can, and partly because most of them have not saved anywhere near enough to fund a comfortable retirement.
  • Household formation will slow. Millennials are massively over-burdened with student debt and will be late in marrying, having children, and buying expensive items, especially homes.
  • The middle classes in China and India will each number more than the entire population of the United States.
  • There won’t be enough fresh water to go around.
  • Global corporations will find ways to profit from technologies that address climate change, water, food, etc… Eventually, the actions (or inactions) of the U.S. Congress will become less relevant to the solutions to these problems.
  • Education matters. Robots will replace more and more unskilled workers. If an Unmanned Aerial Vehicle (drone) can replace a Top Gun Qualified Fighter Pilot, robots will replace one heck of a lot of unskilled workers.
  • The U.S. military no longer has the resources, and the U.S. citizenry no longer has the will to continue to be the world’s policeman. Will some other country pick up that mantle?
  • There are a dozen more visionary inventors like Elon Musk out there.
  • Disruptive technologies will affect more existing industries, in more ways than we can imagine. Unintended consequences will wreak havoc.

Some of these predictions will be right, some will be wrong; more will be right than wrong, I predict. But who knows for certain how the financial markets will respond to any of them…?

At First Affirmative, we believe that, most of the time, well-run companies with managements that focus on being sustainable businesses will perform better than poorly run companies making giant campaign contributions to preserve the past. We believe that people with financial plans, developed by competent financial planners, will be more likely to have an opportunity to achieve an acceptable quality of life in the future.

We believe that First Affirmative is highly competent to provide portfolio management options to those competent financial planners, using managers who are focusing on investments in businesses of the future.

 

Posted: June 18, 2014