An Historic Moment which is Particularly Teachable for C / Suite Clients and Prospective Clients

This sentence appears at the very top of the C/Suite Blog Page on The Bahnsen Group Website:

  • While senior executives are endowed with the same humanity we all possess, their wealth management needs are distinct and often categorically divergent from many other investors.

Too fluffy for you? Please allow us to prove this to you as illustrated by this historic moment in market history that occurred October 5 2021:

  • “Profits are the highest they have been in S&P 500 history.  Profit margins are the highest they have been in S&P history.  And as of right now, the dividend yield on the S&P 500 is the LOWEST it has been in history.  How is this possible?  Very simple – payout ratios that have not grown, and price valuations that have skyrocketed, leaving math to create a yield that is less than that of the 10-year Treasury yield.  Equity investors who want to get paid simply have to utilize an intentional and selective approach towards extracting dividend focus” (emphasis added, see the October 5th edition of DC Today for more).

What’s the solution? Active portfolio management that executes:

  • A continuous, intentional focus on every company name in the portfolio. Many Dividend Growth managers have less than 40 company names in their portfolios.
  • A selection and monitoring criteria that senior management of every company name in the portfolio must
    • Maintain a constant focus on executing exquisite corporate capital allocation, and
    • Continuously increase dividends to reflect management’s ongoing commitment to shareholders to generate increasing free cash flow, maintaining low debt, and growing earnings per share.

This is where we believe the core of our clients’ diversified equity portfolio ought to be situated!

The strategy and design of S&P-types of indexing are easy to understand. Yet, by design, an S&P-type of index strategy’s bias frequently reaches well beyond the risk spectrum of what a senior leader client needs in their portfolio in up or down markets! Let’s unpack this:

  • The PE of the S&P as of 10/1/21 was 30. The PE of many Dividend Growth portfolios is about half that of the S&P, approximately 16 as a customary average.
  • The yield we like on Dividend Growth portfolios is 3X the S&P.
  • The S&P is out on the risk limb with high PE and Low Dividends, which doesn’t mean it is poised to decline, but when it does correct, look out below!
  • We believe our clients have unique risk circumstances directly related to their unique compensation structure. For example, one might think a VP/SVP/EVP/C-level officer of a Fortune 500 company has an extensive portfolio so that they can afford risk!
    • Nay, the public might be surprised to learn that the average leader of a F500 company carries a minimum concentration risk of 50% or better of their investment portfolio consisting exclusively of stock and equity compensation of their employer.
    • By the way, an officer’s income is 100% concentrated with their employer. Due to vesting requirements on equity compensation, this employment risk compounds portfolio risk beyond the scope of this blog and, frankly, is often overlooked by our clients.
    • Nay, the public does not know about the impact of leverage on stock options wherein a 20% drop in the company stock price can have a leveraged negative 60% drop of in-the-money value in a client’s option holdings (because the strike price is fixed)!
      • For example, suppose the broad market is off 20% along with the employer stock. In that case, the investment portfolio of a client who is 60% concentrated might be off 8% in the diversified portfolio (20% of 40%) plus 36% in the concentrated options portfolio (60% of 60%) for a whopping slide of 44% across the entire investment portfolio from a mere 20% drop in the broad market. There is some generalization in this example, but the leveraged risk observation is SPOT ON!
      • A client may decide to take that risk individually and instruct us to accommodate their individual preference for risk. On balance, however, most clients prefer not to take this risk, and their spouses are even less inclined!

The active management of Dividend Growth portfolios can maintain a consistent “risk-adjusted” portfolio, unlike a cap-weighted indexed strategy where some investors might find themselves unknowingly out on the risk spectrum where they do not desire to be.

For example, when analyzing the portfolios of incoming prospective clients, it is fascinating and telling to examine what percent of their portfolio invests in the so-called FAANG technology stocks! Talk about risk:

  • The average PE of FAANG on 10/5/21 was 40.74 (it was much higher in the recent past)!
  • About what percent of the S&P 500 is composed of FAANG? 17%, and if you add Microsoft at 5.9% of the S&P, you get an astonishing 23% concentration of the 500 stocks in the S&P (and many other portfolios), in just six individual stocks within one sector: technology. The overlap of FAANG and Microsoft in the portfolios which prospective clients share with us is remarkable.
    • The concentration of these six technology stocks has been as high as 40% of the S&P in the past 12 months.
  • Question: Is this risk advisable for a senior leader client already 50% concentrated in their employer stock? We don’t think so, and yet many new clients begin this way.
    • We don’t care what other advisors or portfolio managers have to say. We simply ask our prospective clients if they like this risk. Most prospective clients answer that question with a resounding NO without passing Go (for Monopoly fans).
  • Oh, and the average yield of FAANG as of 9/2/21 was 0.12%. Said differently, this is a yield of twelve one-hundredths of one percent! Remember, yield reduces stress across the portfolio in retirement because people don’t spend stock; they spend cash or cash flow. If a security must be sold to be converted to cash, there is a risk. A person holding S&P index investments has much more risk onboard than most realize.

This historic moment is a great time to take another look at risk and rediscover the value of active management of a rules-based style previously discussed. As clients navigate through their most productive wealth-building years and retirement looms closer, their focus moves in parallel to wondering how cash will be generated in retirement. Virtually 100% of our clients are not interested in living for 35-40 years in retirement on a portfolio of growth stocks that must be sold periodically to survive! Instead, our clients seek cash flow from a dividend growth portfolio whose yield is about 3X the S&P and growing annually by a margin that exceeds the inflation rate. The good news is there are many ways to build cash flow into client portfolios without resorting to bonds, but in this instance, our focus has been on Equities and Risk and why our clients need to be mindful of both.

Many new clients have been picking stocks on their own, but as their diversified portfolio begins to hit 1-2 million, it’s not picking stocks that gets troublesome; it’s attempting to monitor their portfolio that gets troublesome. It’s just not fun anymore, and besides, what will the non-financial spouse do if the stock picker gets picked off? A great advisory relationship is of value to the entire family.

As we say to all of our prospective clients: you are our boss. If you work with us, you will still monitor your portfolio, as before. However, your vision will move to a higher level, from individual stock selection to overall portfolio allocation. You are still supervising your portfolio, and you are still in control. As a former stock picker, this new relationship will allow you to earn trust in the team that will be there to serve your family when you are no longer able to do so.

Stoddard Barnhill
sbarnhill@thebahnsengroup.com

Phillip Barnhill
pbarnhill@thebahnsengroup.com

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The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

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Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client’s individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for related questions.

This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.

About the Authors

Phil Barnhill, CLU

Private Wealth Advisor
Director of Risk Management

Stoddard Barnhill, CFP®

Private Wealth Advisor

For nearly 25 years Phil has worked exclusively with senior leaders of public and large private companies. Over the past six years Stoddard has been carefully mentored in this niche market, leading to a highly-specialized practice knowledge within the team. This focus on corporate executives and their family dynamics comes with significant insights into executive compensation, stock concentration, equity monetization, and the full life-cycle of a career in the C-Suite.

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