Investors around the world have been affected by the recent alleged fraud committed by Bernie Madoff, a well-known New York investment manger. Madoff is accused of running a giant Ponzi scheme, where money from new investors is used to pay returns to existing clients. Some wealthy families had all or most of their net worth invested with Madoff, and it is likely that these people will lose everything. The losses are tragic for the families and charities involved.
This scandal highlights one of the major disadvantages of hedge funds, or any other type of pooled investment vehicle, where monies from more than one client are combined into a single account. Called “lack of transparency,” it means that you never really know what you own or how much it is worth. Our business is set up differently in order to eliminate this risk, and there are two primary reasons why this type of scandal could not happen at Parsec. First, we do not take custody of any client assets. Client accounts are all held at a reputable third-party custodian such as Charles Schwab & Co., Fidelity or TD Ameritrade. Your assets are always in your name in your account, where you can see them online or call the custodian and get a current balance and list of holdings. Second, we do not have the authority to get money out of your account without your signature. These protections are key distinctions between our approach and a pooled account.
As of this morning, the 10-year Treasury Note yield is 2.12%. This implies deflation over the next 10 years, as historical inflation has been significantly higher than this level. The government has pumped a huge amount of liquidity into the financial system in the form of interest rate cuts and various bailout packages, and we believe this will eventually be inflationary. Keep in mind that inflation is one of the major risks to fixed income investments over time. The dividend yield on the S & P 500 is currently about 3.1%. The implication is that stocks at this level would outperform Treasury Notes even with no capital gains over the next 10 years. For this reason, we are not particularly interested in buying Treasury Notes at current prices. For our clients that have an allocation to fixed income, we are currently focusing on inflation-protected Treasury securities, and high-quality corporate and agency bonds that are currently trading at wider than normal yield spreads.
One benefit of the current interest rate environment is the decline in 15 and 30-year fixed rate mortgages, both of which are currently just under 5%. While it is possible that mortgage rates could move slightly lower, we do not believe that they will stay at these levels for long. We encourage all of our clients with fixed rate loans at higher interest rates, or those of you on adjustable rate mortgages, to consider refinancing in order to lock in your borrowing costs at currently low levels.
We thank all of our clients for their perseverance over the past year, and wish you and your families a happy and healthy holiday season.
Bill Hansen, CFA
December 19, 2008