Track Record
It's important to realize that the effects of compounded returns cause seemingly small
differences to accumulate into amounts that are rather significant for your lifestyle
in retirement. Our help can have a very large impact on your ending wealth.


trackrecord1Ray Meadows, the investment manager and president of Berkeley Investment Advisors, has managed his personal portfolio for over 16 years. From 1999 to the end of 2014 his cumulative return was 294% compared to 116% for the S&P 500 index. As you can see, superior returns really can make an important difference over long time periods.

Looking at the long run is important because it is the erratic results in the short run that can lead to emotional decisions that wreck your chances for superior long run returns. Ray's conviction in his analytical abilities and investment skill allow him to stay the course and reap the rewards of his focus on business and economic fundamentals. After all, in the long run cash flows over-rule emotions in the investment world. Our strategies are designed to outperform over periods of longer than 5 years under normal market conditions. We will tend to underperform in speculative driven bull markets because we actively manage risk; we are unwilling to accept the deep losses that inevitably follow from investing in over-valued stocks near the peak of the market. In the long run this will produce higher returns by preserving capital during large down moves so that it can be deployed when returns become more attractive relative to risks.

Client Returns

At Berkeley Investment Advisors, we implement our investment strategies in a number of different risk portfolios. We allocate client money among these strategies according to their risk tolerance. Our primary equity portfolio is called Long-Term Value. One client has been continuously invested in this strategy since April 2005. In January 2008 we inferred from economic data that the U.S. was entering recession and initiated a risk reduction strategy. As part of this shift, we moved a portion of client funds into two new income oriented portfolios: Long-Term Income and Short-Term Income. This reduced clients’ overall exposure to risk while still generating a reasonable return.

Long-Term Value Portfolio Strategy and Performance

The Long-Term Value portfolio is meant for clients with a Long-Term investing horizon who are willing to take moderate risk in pursuit of equity market returns (i.e. higher than fixed income returns). The objective is to earn returns at, or above, those available in the general stock market but with less downside risk. This portfolio is invested in exchange traded funds (ETFs), Real Estate Investment Trusts (REITs), stocks, and other equity securities.

We focus the portfolio on a relatively small number of stocks selected based on our assessment of expected Long-Term returns. We make use of several independent research providers to help us indentify potential investments. The most important source is a screening tool that looks at companies with significant insider buying of their shares. On top of this, we layer our own valuation criteria and review financial statements to assess value. The goal is to find stocks that should produce returns of at least 10% annually.

Expectations of returns are based on how much the company is likely to earn, what this should imply for the future stock price, and the current market price. Since our projections for a given company change slowly, the current market price is the most important driver of changes in returns. As the current price rises, future returns are declining, and vice versa. Basically, we are comparing our assessment of value to the market price: we want to buy as the price drops below value, and we want to sell if price goes (too much) above value. It sounds sensible – buy low and sell high. But it means going contrary to the market. As the market rises, we sell many positions and it becomes difficult to find replacement stocks offering high enough returns to justify the investment risks. This leads to larger cash holdings when the market goes up to very high valuation levels as in 2013. This may cause us to earn lower returns in overvalued markets because we end up holding a lot of cash. Conversely, when the market declines sharply and more stocks fall below true value, we have a chance to use our cash to buy at prices that provide better returns over the long run.

In order to calculate returns for this strategy we selected the client who has had money in this strategy the longest and analyzed their account in great detail. To correctly calculate returns we must properly account for all money going into or out of the strategy, including dividends and fees. The return calculations here cover the period from April 30, 2005 to April 30, 2015, a period of 10 years. Over that time, the Long Term Value portfolio produced a cumulative return of 130.8% compared to a cumulative return of 120.6% for the S&P 500 exchange traded fund. This return is calculated net of the 1.25% annual fee paid by the client. So the portfolio return exceeded the benchmark by 10.2%. This works out to about .5% higher return annually over the period.

The chart below shows the path of returns. As you can see there is quite a lot of volatility in returns. Excess returns were very high just after the market crashed – this provided us lots of cheap stocks to buy. More recently our returns are low relative to the market as it approaches record valuation levels. Patience is a virtue in investing.

LongtermSP500

Client returns data includes reinvestment of dividends after netting out fees and expenses. Note that our client portfolios are much less diversified than the S&P 500 index and therefore exhibit higher short run volatility. As explained in the section on The Relationship of Risk to Investment Time Horizon, our view is that short run volatility is not an appropriate measure of risk of loss for Long-Term investors.

Long-Term Income Portfolio Strategy and Performance

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The Long Term Income portfolio is a fixed income portfolio that focuses on intermediate to long term maturity bonds. Typically longer maturity bonds offer higher interest rates (yields) than shorter maturity bonds and are more sensitive to changes in interest rates. We measure interest rate sensitivity risk as duration. This tells us how big a change in price we can expect when interest rates change. Typically a long term bond fund strategy would own bonds with durations above 8 given that 10 year treasury bonds have duration of 9.25. If we held a bond with duration of 8 when rates went up 1% we would expect the bond’s price to decline by 8%. In the current environment where long term interest rates are historically low, we have chosen to keep duration to a lower level –3.8 as of Septermber 2015.

Besides interest rate risk there is also credit risk in our bond portfolio – the risk that borrowers may default and not pay all that is due. Lower rated bonds, known as high yield or junk bonds have a higher probability of default than higher rated bonds but compensate by paying higher interest rates. In a sense default risk is similar to equity market risk as it is correlated with the performance of the economy. Individual credit risk is managed by diversifying across a large number of issuers. In this way we insure that the extra premiums earned will not get wiped out by a few companies defaulting. Given that the weakest credits defaulted during the last recession and the overall low level of interest rates, the return versus risk trade off has been very favorable in lower rated bonds. Our strategy is to accept these credit risks to earn those extra returns.

Another source of incremental yield comes from buying closed end funds that have lower trading volumes than typical exchange traded funds. These securities can be bought at a discount to the underlying bond values (and sometimes sold at a premium). In addition these funds can enhance returns through embedded leverage at very low cost of funds thereby enabling us to capture some of the rate subsidy targeted at banks by the Federal Reserve. In holding these securities we must endure more price volatility in down markets as retail investors tend to want to sell more at lows. Current market conditions are providing about 2.5% higher yield on our portfolio than if we held the underlying bonds directly.

The portfolio is diversified across virtually all sectors of the fixed income market, including government bonds and mortgage backed securities. A good comparison index is the Barclays U.S. Aggregate Bond Index as represented by the iShares Core Total U.S. Bond Market exchange traded fund (ticker AGG). This is meant to represent the total overall U.S. bond market.

Although we first created this portfolio in February 2008, it was not continuously invested until September 2009. Therefore we cannot calculate performance further back than September 2009. The graph and table below show total returns including price and interest payments in comparison to the bond index mentioned above as implemented in the exchange traded fund (ticker AGG). Our portfolio returns calculated here are based on a particular client’s account and have been reduced by annual fees of 1.25% which would apply to new accounts above $500,000 but below $1 million.

Returns by Year

Year Ended:

Longterm Income

AGG Bond Index Difference
9/30/2010 19.8% 7.4% 12.4%
9/30/2011 1.2% 5.0% -3.8%
9/30/2012 23.1% 5.0% 18.1%
9/30/2013 0.2% -2.0% 2.3%
9/30/2014 7.6% 4.1% 3.5%
9/30/2015 -6.3% 2.9% -9.2%
Compounded Total 50.8% 24.2% 26.6%

LongtermvsAGGETF

The annualized rate of return from September 30, 2009 to September 30, 2015 has been 7.1% despite the dramatic pullback of the last 5 months. The table above makes it clear that the strategy exhibits significant volatility in returns and the current year is by far the worst ever.

The market goes through cycles of risk seeking and risk aversion whose timing is unpredictable. These cycles drive shorter term returns in stocks and bonds. While we cannot know the timing of any particular cycle, we can be confident that the market will eventually swing the other way. High yield bonds are priced to deliver higher returns than the major stock indices over the next few years.

As of September 30, 2015, the yield on the Long Term Income Portfolio is 9.5%. The average discount of our closed end fund holdings relative to their net asset value is more than 15%. I expect these discounts to move back below 10% within the next 2 to 3 years.

Short-Term Income Portfolio Strategy and Performance

The Short-Term Income portfolio is a fixed income portfolio that focuses on short to intermediate term rate maturity loans and bonds. Typically shorter maturity bonds offer lower interest rates (yields) than longer maturity bonds and are less sensitive to changes in interest rates. This category of fixed income includes securities with floating interest rates that can reset periodically depending on market conditions. For example the rate paid could be set based on the 3-month London Interbank Offer Rate (3-month LIBOR).

We measure interest rate sensitivity risk as duration. This tells us how big a change in price we can expect when interest rates change. Typically a Short-Term bond fund strategy would own bonds with durations below 3. If we held a bond with duration of 3 when rates went up 1% we would expect the bond’s price to decline by 3%. In the current environment where interest rates are historically low, we have chosen to keep portfolio duration to an even lower level – 1.2 as of March 2015.

Besides interest rate risk there is also credit risk in our bond portfolio – the risk that borrowers may default and not pay all that is due. Lower rated bonds, known as high yield or junk bonds have a higher probability of default than higher rated bonds but compensate by paying higher interest rates. In a sense, default risk is similar to equity market risk as it is correlated with the performance of the economy. Individual credit risk is managed by diversifying across a large number of issuers. In this way we insure that the extra premiums earned will not get wiped out by a few companies defaulting. Given the favorable economic conditions (except for the energy sector) and the overall low level of interest rates, the return versus risk trade off has been very favorable below investment grade rated bonds. Our strategy is to accept these credit risks to earn those extra returns.

Another source of incremental yield comes from buying closed end funds that have lower trading volumes than typical exchange traded funds. These securities can be bought at a discount to the underlying bond values (and sometimes sold at a premium). In addition these funds can enhance returns through embedded leverage at very low cost of funds - thereby enabling us to capture some of the rate subsidy targeted at banks by the Federal Reserve. In holding these securities we must endure more price volatility in down markets as retail investors tend to want to sell more at lows. As of November 2015 market conditions are providing about1.45% higher yield on our portfolio than if we held the underlying bonds directly.

The portfolio is diversified across virtually all sectors of the fixed income market, including government bonds and mortgage backed securities. A good comparison index is the “Barclays U.S. 1-5 year Government/Credit Float Adjusted Bond Index” as represented by the Vanguard Short-Term Bond exchange traded fund (ticker BSV). This is meant to represent the short maturity U.S. bond market.

At least some clients have had money invested in this portfolio since it was created in February 2008. The graph and table below show total returns including price and interest payments in comparison to the bond index mentioned above as implemented in the exchange traded fund (ticker BSV). Our portfolio returns calculated here are based on a particular client’s account and have been reduced by annual fees of 1.25% which would apply to new accounts above $500,000 but below $1 million. Calculations are from 2/28/2015 to 4/30/2014.

Returns by Year

Year Ended: Short-Term Income BSV Bond Index Difference
3/2008-2/2009 1.4% 3.1% -1.7%
3/2009-2/2010 10.3% 5.0% 5.4%
3/2010-2/2011 5.5% 2.7% 2.8%
3/2011-2/2012 5.5% 3.4% 2.1%
3/2012-2/2013 17.5% 1.1% 16.3%
3/2013-2/2014 0.5% 0.6% -0.2%
3/2014-2/2015 2.0% 1.1% 0.8%
7 Year Compounded Total 49.8% 18.4% 31.5%

Despite the pullback from the high hit in April 2013, the table above and graph below show the cumulative return for the strategy from 2/29/2008 to 2/28/2015 as 49.8%. Thus the annualized rate of return over the first 7 years has been 5.95%.

The table above and the chart below makes it clear that although the strategy exhibits some volatility in returns, there is much lower risk of principal loss over a year’s time than in other strategies - such as stocks or Long-Term bonds. This is the reason that many of our clients have large allocations to this strategy: we are being cautious in what appears to be a speculation driven market. The stock market looks particularly risky using historical norms. We want to avoid large losses and have funds available to buy when the market returns to a lower level.

ShortTermBSV