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Buying quality goods at marked down prices Ather Bajwa, CFA 283 W Front St #302 Missoula, MT 59802

An investment in any security is a claim on the net expected cash flows that will be delivered to investors over the time period that a security is held. When investing in a work of art the only cash flow an investor is entitled to is the eventual sale price, which hopefully is more than the purchase price and associated cost of owning (e.g. auction house premium, taxes, framing, storage, upkeep and insurance). In the case of an investment in a certificate of deposit or a bond bought at par (original value loaned), the cash flows an investor is entitled to are the regular interest payments and the amount invested. Equity investors on the other hand generally expect a periodic dividend payment and a potential gain on the original investment (capital gains). In the case of equities neither the dividend payments nor the capital gain is certain, hence the large day-to-day gyrations in the value of a stock. For any investor the central tenet of a successful investment strategy is the ability to correctly assess cash flow expectations relative to the cost of investment. While many factors influence investment performance (e.g. interest rate movement, GDP growth, investor preferences) the key component of an asset’s performance is the original cost of investment. Consider the example of the US stock market. Since 2000 the S&P 500 has delivered an average annual Figure - 1 return of 1.7% – money market funds have reported better performance. Many investors have come to believe that stock market performance is largely dependent on two factors, corporate earnings growth and US economic performance. Yet since 2000, corporate earnings have improved by over 50%, while US GDP has increased by almost 60%. So what gives? During 2000 investors drove the cost of investing in US stocks to record highs, paying nearly $45 for every $1 in corporate earnings – three Source: Robert Shiller times the 125 year average (Figure-1). When one overpays for an investment, chances are they are going to be disappointed with that investment’s returns. NASDAQ investors have had an even worse time – nearly fifteen years later the index is still 25% below its 2000 value. A successful investment strategy is one where investors outperform over extended periods of time (a complete market cycle). During the 2008-2009 financial crisis John Paulson successfully bet big against sub-prime mortgages, even prompting a bestselling book “The Greatest Trade Ever.” Since then however Mr. Paulson’s record has been rather checkered, his Advantage Plus fund fell 52% in 2011 and another 20% in 2012. History has shown time and again that investor ability to avert losses is far more critical to achieving exceptional, positive, long-term returns as compared to focusing on securing shortterm, speculative profits. Although the average return of a bull market is approximately 160%, during a typical bear market more than half of all these gains are lost (Figure-2). A successful investment strategy is one that best manages the downside.

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Buying quality goods at marked down prices Ather Bajwa, CFA 283 W Front St #302 Missoula, MT 59802

Apart from focusing on cost of the original investment and effectively managing downside risk, another vital component of triumphant, long-term investment performance is the type of assets an investor purchases. Among stocks, arguably the most common distinction drawn is growth versus value investing. Growth companies are expected to increase their earnings at a rapid pace, whereas value Figure - 3 stocks are considered undervalued, dividend payers. While it may be tempting to emphasize companies that are growing at a fast pace, the question any investor needs to ask is, “what price am I willing to pay for that growth?” Although at times growth orientated investors have outperformed their value brethren by large margins (in 2009 growth stocks increased 37% versus value 20%), over the long term Source: Lord Abbott value investors have bettered growth oriented ones by a wide margin while taking less risk (Figure-3). In 1999, Warren Buffet’s Berkshire Hathaway saw its share price decline by almost 20%. The S&P 500 during the same period rose by 19%. Mr. Buffett’s style of investing was called “washed-up.” However, he backed his discipline of investing in value orientated, under-appreciated stocks. His belief of investing in proven businesses may have seemed out-of-date to technology fixated, new-economy backers, yet the proof is in the pudding. Since 2000 Berkshire Hathaway has bettered the S&P 500 three times over. Currently, US equity markets are trading at all-time highs. Our investment discipline of managing down-side risk, focusing on companies that are priced to deliver superior risk-adjusted return and investing for the long-term has served our investors well in both bull and bear markets. While speculation and chasing returns has worked for certain traders over some time periods, successful investors always focus on due-diligence and the long-term. Our emphasis on low volatility, higher than average dividend yield and low cost securities has outperformed the stock market over a complete market cycle. While our strategy may not outpace its benchmarks on every occasion, we have shown that patience, prudence and a long-term view are the reasons for consistent investment success no matter what the circumstance. 80% SGLIA Growth & Income Portfolio Performance 60%

2007 to 2013

40% 20% 0% -20% -40% -60% 1/1/07

G&I 1/1/08





S&P 500 1/1/13


Past performance is not indicative of future results. All returns are gross of any management fees.

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