Investment Management

Berkeley Investment Advisors invests in undervalued U.S. and foreign securities where we can leverage our fundamental valuation expertise, our knack for understanding the financial impact of economic trends, and our ability to synthesize and quantify other qualitative factors affecting long-term investment values. I will explain the investment strategies I employ on behalf of clients, my experience and investment track record, and the details of how the accounts will work. If you have significant liquid assets, it will definitely be worth your time to understand what we offer and how it differs from other alternatives in the market: Ray Meadows has significantly outperformed the S&P 500 index over the last 9 years – check his track record here. 

It used to be very costly to set up the infrastructure to manage client money while meeting all the regulatory requirements. Recent advances in brokerage firm technology have reduced these costs so that now I can offer customized money management services in a cost effective way. Thus I am offering separately managed accounts for investors with as little as $100,000 to invest. By using a cutting-edge online brokerage platform, I can use my expertise to customize portfolios and still charge no more than you would pay for a run-of-the-mill mutual fund. 

Intelligent Investment

Academic studies in the field of behavioral finance show that, on average, investors make sub-optimal decisions relative to alternative passive strategies. Generally passive strategies are those where you buy and hold a well diversified basket of stocks. In fact actively managed mutual funds, on average, lag the overall market return. Thus, it is argued, the best investment strategy is to buy an index fund so as to guarantee you won’t underperform the market.  On average this should be better because (in theory) it eliminates the source of investor errors and biases: emotions. Unfortunately it also eliminates reasoned analysis at the same time. So you give up the upside to eliminate the downside.  There is a better way: take out the emotions without turning off the other half of your brain. 

There are investment managers who can consistently outperform the market.  The problem for academic studies is that these managers are hard to identify with statistical methods and their performance generally does not fit neatly into any existing academic theories. (Any professor who discovers a way to predict superior performance is quite likely to drop out of academia to set up a hedge fund to exploit his findings).  If you can find such a manager you can do much better than a passive strategy.

For us, the path to superior performance is clear, we focus on analysis and expected long term results to guide our decisions. Our investment time horizon is long and our past results from reasoned investment decisions have been excellent. This inspires the confidence to resist the influence of short term psychologically driven volatility which has no connection with the fundamental factors upon which we base investment decisions. 

What it Takes to Consistently Outperform the Market

Lots of people earned very high returns during the bubble years and they thought themselves brilliant investors. They were not. It took a bear market to show that they had been lucky and, in fact, had no investing skill or viable long run strategy. As an investor, I have a lot going for me: 2.5 degrees in business, one in economics, a C.P.A. and C.F.A., plus years of banking and Wall Street experience. But when I think about what it is that makes me a successful investor in securities, I see three things that stand out from the rest:

• Strong focus on analyzing fundamental value as derived from earnings and cash flows;
• Big picture perspective – a solid understanding of how the economy works, current trends, and the implications for industry and company financial performance; and 
• Attention to, and careful assessment of, qualitative indicators of future performance.

The last of these deserves a bit more explanation before I illustrate how these competitive advantages tie in to investment strategies. I’m talking about understanding the stock or bond performance implications of the news and other non-financial information. Most importantly, this is about accurately identifying those companies with superior business models and strong management. (Of course it’s also important to identify those companies with poor prospects and weak management in order to avoid them.) Other qualitative factors that come to mind include: accounting issues/scandals, insider transactions, politics, mergers and acquisitions.

Investment Strategy

We will implement several different strategies on behalf of our clients but the common theme of all is to find market niches where returns are high relative to the risks because of a lack of understanding or attention on the part of the big institutional players in the market. (Note that this is also the reason why real estate has historically been a source of high returns for individual investors.) Based on my investment experiences I have identified 4 strategies that flow from my competitive advantages versus other money managers in the market:

• Long Term Winners
• Under-appreciated Income and/or Growth
• Market Overreaction Contrarian Investments
• Opportunistic Liquidity Provision

 Sometimes a single stock may fit more than one of these strategies. 

All long term investors want to pursue the first strategy: buying companies that are Long Term Winners. Warren Buffet follows this strategy and has done extraordinary well with it. Making good money with this strategy requires an ability to recognize how demographic and economic trends will affect an industry’s revenue growth and competitive environment (i.e. profit margins), a knack for identifying companies with the management talent and business model necessary to capture a large part of the value created by those trends, and a close look at the company’s current valuation to make sure the market has not overestimated its future prospects or underestimated the risks it faces. 

The second strategy, finding securities with under-appreciated income and/or growth, usually involves smaller companies not well followed or understood by Wall Street. Here we are looking for companies that already generate substantial free cash flow, who have good prospects for moderate growth in cash flows, but whose stock valuation is low relative to current cash flows. For example, a company that is already generating earnings equal to 8% or more of its stock price would be a very good deal if we could be confident of 10% annual growth in such earnings. Such earnings are even more valuable if a substantial portion is paid out in dividends because in this case we don’t even need the market to realize the value – the cash is going into our bank account. Fundamental valuation and qualitative risk assessment are important to finding these opportunities.

My third strategy is my favorite because it can really boost a portfolio’s returns. Unfortunately these opportunities do not happen very frequently so you must use other strategies and patiently wait for an “event” to happen. What I’m talking about is big news that causes institutional players to overreact by selling off a security far below its real value. By correctly estimating the economic impact of news and accurately assessing the fundamental value of a security being sold off by the market, we can bravely buy when others are selling in panic. Such contrarian trades pay off big when the market calms down and enough investors realize that the worst case scenario has, in fact, not happened 

The fourth strategy is best explained in the context of market structure. Liquidity is the ability to buy or sell shares without significantly affecting the price with your transaction. Wall Street firms provide liquidity by standing ready to buy at their bid price or sell stocks at their ask price. On average they get paid the bid-ask difference as their compensation for this service. What I call Opportunistic Liquidity Provision is a longer term version of this market making function. What we look for is a good company that we understand the long run value of, which is relatively thinly traded. In this situation we will observe the stock price fluctuating around its true value with significant deviations in the absence of news. We can profit from this by providing liquidity to sellers at our bid price (the low end of the trading range) and liquidity to buyers by selling at our ask price: the “true” value of the stock (near the high end of the trading range within which the stock fluctuates). There is always some risk that some news will go against us while we’re waiting for the buyers to show up. For this reason we use this strategy only on stocks that we are confident will pay off in the long run as well as the short term (i.e. they also fit another strategy).  

Results Using These Strategies

In the interest of brevity, I will limit my discussion of specific examples but I would be happy to share more details with anyone who is interested. Over the last 9 years I can identify several major “themes” that illustrate the strategies. My first investment theme was profiting from the turmoil in emerging markets in the late ‘90’s. I bought Russian bonds, Brazilian bonds (also 2003 election), and a Mexican cement company when the big institutional traders were selling like crazy to meet margin calls. Then, in 1999 I started buying Real Estate Investment Trusts (REITs) when they were out of favor and continued to buy under appreciated companies until the market finally recognized their value and bid them up to what I consider “true” value. Next, I bought companies that were oversold in the wake of 9/11 (mostly reinsurance). Later, I profited from the Freddie-Mac accounting scandal and the Insurance industry scandal - thanks to short-term market mis-pricing of these securities.  My most recent investments in beaten down financial stocks have yet to pay off, but these have large potential gains given their underlying earnings potential.

On an absolute return basis I have done very well. My annualized rate of return over the nine years ended 12/31/2007 was 19.5%. You may not think much of this until you realize that this period covers one of the worst periods in market history. The S&P 500 index return over this period was just 3.4%. Cumulatively this means that $100 invested 9 years ago in the S&P 500 would have grown to $135 while my $100 grew to $498. Not only did I beat the market by 16% annualized over a 9 year period, but I also beat it consistently. By this I mean I outperformed the S&P 500 eight calendar years over the nine year period.

Although my strategy uses concentrated portfolios that tend to exhibit significant short term volatility, my strategy of buying at large discounts to underlying asset value is a very low risk strategy when viewed over a time frame appropriate to revealing fundamental value. (For a detailed discussion of the relationship between risk and time horizon click HERE). Over my 9 year track record the lowest return for any 5 year period was 60%. In comparison, the S&P 500 had a loss of 11% over this same 60 month period. Such a favorable downside result is a much more relevant measure of risk than the industries standard short term volatility measure – so long as you are a long term investor. (I would not recommend my equity strategies for those with short term investment horizons).

The Product: Risk Tailored Portfolios

Based on each client’s investing horizon, risk tolerance, and return goals we will recommend spreading their money across four tailored portfolios summarized in the following table.

Portfolio Name	Risk	Example Investments
Parked Money	Very Low	Short term bond ETFs, variable rate preferred stock
Long-Term Income	Low	Longer term bond ETFs, fixed rate preferred stock, mortgage REITs
Long-Term Value	Moderate	Stock picks: Long Term Winners strategy, Under-appreciated Income and/or Growth strategy
Special Situations	Market	Stock picks: Market Overreaction Contrarian strategy, Opportunistic Liquidity Provision strategy

See a discussion of Risk Management here.