Most investors think quality, as opposed to price, is the determinant of whether something is risky.  But high-quality assets can be risky, and low-quality assets can be safe.  It’s just a matter of the price paid for them.

– Howard Marks (Sept 2015)

It seems not a day goes by where a media outlet or publication doesn’t run a story on the death of active management. Whether these stories note the current tidal wave of money being dumped into low-cost index mutual funds and exchange traded funds (ETFs) or the idea that some large percentage of active managers fail to beat their benchmark, it’s all the same story.  Even notable investing legend Warren Buffett in his annual letter to shareholders[1] recommended that individuals allocate almost all their investable assets to an S&P 500 index.  Everywhere you turn, the drumbeat of passive investing is audible.  But is it a siren’s song?

Doesn’t it strike you as odd that humans spend countless hours getting the “best deal” on items to include toothpaste, cable bills, gasoline, and groceries, and yet do not put in equal amounts of effort to a far more critical commodity: their financial assets?  Put another way, the word “deal” as described in the prior sentence is meant to imply a recognition of price consciousness.  The passive approach to investing mandates that you ignore your inner drive for price consciousness.  To me, this behavior seems a little strange, but recent flow of funds data[2] would suggest that many investors are, in fact, eschewing price consciousness in favor of simple “market exposure”….just as the equity markets touch new all-time highs.

As with other manias in financial markets history, we think what is really going on here is momentum investing.  In financial markets, the phenomenon of momentum refers to the positive feedback loop that is created by prices that go up over a short/intermediate-term time frame.  This upward bias in prices draws in additional investors near the mid-to-latter stages of the cycle as FOMO (Fear Of Missing Out) creates a buying frenzy.  Investor memories can be myopic, and you don’t have to look hard for examples of this activity.  Some would include: technology stocks in the late 1990s, single family homes in the mid-2000s, master limited partnerships (MLPs) in the 2010s, and the soup du jour is exchange traded funds (ETFs) based on indices.

So why is it a problem that so many investors are now price insensitive, and how are we (Gratus) accounting for this new potential risk?  We touched on this topic in an update last year, but I believe it’s time to revisit the issue as the answer may not seem obvious.

Low Cost ≠ Low Risk

We’ve put this idea first, as we think it is the most important concept to consider when thinking about an ETF or index mutual fund.  Just because the vehicle is low cost (ETF/index mutual fund) does not mean that the assets underlying the vehicle do not carry risk of over-valuation.  Many in the financial media will eschew this point by saying something nebulous like “in the long run” or “over a full market cycle” to indicate why your entry point is irrelevant.  To us, these phrases are meaningless, because every investor’s time horizon is different and considerations around their financial assets are unique to some degree.  So to reinforce the point, just because you can buy an index that has a low management fee does not mean you aren’t paying too much for the underlying assets.

Someone Needs To Do The Hard Work

To us (as we’ve mentioned in prior publications) successful investing all comes down to basic probability analysis and, by extension, risk/reward.  The only way we know how to pass judgment on risk versus reward is to relate an investment to its valuation (i.e. is this investment a good deal relative to how good a deal the investment was at various points in the past or to its future prospects?).  There are many ways to gauge value, but for simplicity’s sake, we will use the price-to-earnings (P/E) ratio.  Simply stated, the P/E ratio relates the share price of a company to the earnings it generates.  The higher the P/E ratio, the worse of a value it becomes and the lower the probability becomes that the subject company shares can perform in line with historical norms.  This is a gross simplification of all the variables that go into the P/E and a rigorous company valuation, but the concept helps underscore a point.  The only investors that undertake company valuation analysis are active investors….not passive index or smart beta investors.  Therefore, if fewer and fewer investors are willing to undertake valuation assessments, then who is judging whether a company is overpriced or not?  Clearly, it’s not the index/ETF contingent.  

Ease of Trading ≠ Better Investment Outcomes

Just because you can trade an ETF (buy or sell) intraday, whenever you feel like it, doesn’t mean that this liquidity is a good attribute.  In fact, Gratus (and others like Credit Suisse Global Strategist Michael Mauboussin) would argue that the more liquid an investment, the more likely it is that an investor will trade that investment.  This is partly due to loss aversion, whereby losses that an investor experiences (whether realized or unrealized) feel three times worse than gains of an equal amount.  Behavioral psychologists Daniel Kahneman and Amos Tversky documented this concept (known as prospect theory) in their academic paper.[3]

Leaving loss aversion aside, buying a low cost index ETF does not guarantee a good investment outcome because the purchase of an ETF implicitly involves investment decisions to include what size companies to purchase (small v. large), where those companies should be domiciled (US v. international), type of company to be purchased (growth v. value), currency exposure, % weighting in the portfolio (overweight v .underweight), among others.

Next, there are instances of equity index /ETFs that actually trade at premiums to the companies within the index they are replicating.  In this way, investing in these select ETFs means you are paying more than you would if you were to buy the underlying constituents.  This is not supposed to happen in an ETF.  Admittedly, this doesn’t happen very often, but when it does (as was the case with the Van Eck Junior Gold Miners) it makes news as the ETF marketing machines have placed considerable emphasis on minimal premiums and low cost.

Contrast the high-frequency trading of ETFs with some of the most successful investment programs, and we believe that the intra-day liquidity of ETFs is more of a marketing tool than an actual benefit to investors.  In the case of Gratus, we prefer to hold our equity/ETF positions multiple years (if not decades). 

Market Structure Degradation

I’ve left this section for last as it may be a little less intuitive than the sections above.  I won’t go into too much detail here but wanted to show a chart that may shed some light on this section.  Put simply, we now have a dynamic where an increasing number of ETFs are being created while the number of underlying stocks are declining.  What new risks does this dynamic present?

Next, obtaining diversification within a portfolio of indices/ETFs is now harder to obtain.  Take the case of ExxonMobil.  It’s a mega-cap energy stock with ample amounts of trading liquidity in its shares and an above-market dividend yield (3.8%).  Due to these qualities and the way these attributes are weighted in both market capitalization as well as factor-based indices, ExxonMobil finds its shares a top 10 holding in a surprising number of ETFs, to include iShares Core Dividend Growth ETF, iShares Russell 1000 Value ETF, PowerShares BuyWrite ETF, SPDR MSCI USA Quality Mix ETF, Goldman Sachs Active Beta US Large Cap Equity ETF, John Hancock Multifactor Large Cap ETF, SPDR S&P 1500 Momentum Tilt ETF.[4]  Does ExxonMobil really fit the requirements of all these types of investment vehicles?  You can see the issue in trying to reduce overlap in an ETF portfolio where a single stock is held in many different indices.  True diversification is harder to attain, which is why at Gratus we are migrating our portfolios to more active approaches.

Finally, within the context of market structure degradation, we will spend a little time on factor-based approaches to ETF/index construction.  In the media, factor-based approaches are commonly referred to as “smart beta”.  While the concept of smart beta is a valid approach to index construction (whereby stocks are selected not just by size but also other factors to include dividend yield, volatility, valuation, momentum) the problem lies with the mass adoption of the concept.  I would note that most major investment firms, to include behemoths like Dimensional Fund Advisors (DFA), now have smart beta index ETFs as a product offering.  Observing this build-up in enthusiasm, our thoughts turn to the risks: if we all agree that equities are trading at elevated valuation levels generally, then what good does weighing by slightly lower P/E or slightly higher dividend yield provide…… if everything is overvalued?  This is where an active manager’s decision on what constitutes absolute value from the smart beta relative value becomes important.  This distinction can be seen very clearly in periods approaching major turning points in the equity markets (e.g. 1929, 1970, 2001).


In summary, as we have outlined above, there are many reasons to be wary of the passive investment revolution.  So how are we addressing this potential issue in our portfolios?  First, by recognizing that index mutual funds and ETFs have advantages and disadvantages.  This is a big first step because the financial media and marketing machines like Vanguard and Blackrock have powerful platforms to spread their message which usually revolves around the ideas that (1) there is nothing to fear with index investments and (2) cost is the only area where an investor should focus.  This, of course, is way too short-sighted.  As even Vanguard founder Jack Bogle would admit, there are limits as to how many market participants could engage in indexing.

The simple fact is, no one knows the exact percentage amount where passive ownership in equity indices becomes problematic.  We would argue that the math of index investing indicates we are closer to this problem area than many realize.  As an investment firm, and not a marketing firm, Gratus has no preference in favor of any investment vehicle.  Our concern is to provide high quality investment counsel and identify the appropriate strategies to achieve specified goals and objectives with the least amount of risk.  For many of the reasons listed above, Gratus has been migrating toward select active investments as we believe better opportunity lies ahead for active strategies with a discernable value proposition.  In an era where price is seemingly becoming increasingly irrelevant, we at Gratus Capital remain committed to the concepts of a value-oriented approach, as we believe that value (or price consciousness) is one of the few time-tested investment strategies leading to long-term success.


[2] Investment Company Institute 2017 Factbook

[3] Prospect Theory:  An Analysis of Decision Under Risk (1979).

[4] Horizon Kinetics, “Indexation: Capitalist Tool”, October 4, 2016

Authored By:

The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.

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Each quarter we ask Gratus Capital’s investment experts Todd Jones or Marc Heilweil to weigh in on the current financial environment—addressing key issues you’ll want to have on your radar. This spring we reached out to Todd Jones, Director of Investments, to learn more about critical market trends.

Here’s what Todd is talking about this spring:

Are you concerned about current market levels being so high? If not, what are the reasons you are comfortable with staying invested in stocks?

We are eight years into the current bull market in equities, and all indications point to a continued upward bias. Yes, there are indicators that are flashing caution signs that occurred around previous equity market highs (e.g., elevated Schiller P/E, record margin debt, record profit margins, high levels of insider selling, etc).

Yet these are all known issues which are currently being discounted by the market. On the positive side of the equation, there is no denying that while the U.S. economy may be slowing down a little, other parts of the globe are counterbalancing this slowdown, particularly Europe.

This brings us to why we are comfortable with our global equity holdings at this point in the market cycle.  The primary reason we remain fully invested is due to the fact that we’ve been transitioning a portion of our equity holdings away from U.S. based companies to (primarily) European-based companies given their significant valuation and yield difference.

According to data from JP Morgan, the price-to-earnings ratio for the next 12 months on the S&P 500 sits at 17.49x while the MSCI EAFE is a more reasonable 14.86x.  On a yield basis, the S&P 500 current dividend yield is 2.01% while the MSCI EAFE yield is 3.03%.

In all, we recognize that financial markets are cyclical.  We just believe that there are a number of positive factors at work right now that lead us to believe that there is still a decent way to go until we reach the end of the current market cycle.

What are the biggest risks you see with the global stock markets right now?

It’s important to recognize that predicting what will be the catalyst for the next downturn with any degree of accuracy is next to impossible. Market turns are usually a confluence of events conspiring to sap investor confidence to a point that leads to a mass “sell” in the markets.

That being the case, the biggest risks to global stocks within this mosaic approach appear to be two-fold: (1) a rapid change in inflation expectations (which causes bond yields to rise quickly) and, (2) a rapid rise in the U.S. dollar.

The impact of either of these events would be a reduction in global liquidity. A reduction in global liquidity is a difficult environment for risk-seeking assets like stocks, as leveraged holders of equities can be forced to liquidate their holdings to meet capital calls in other parts of their portfolios. Post-2008, global central banks have broadly filled the liquidity gap with assets purchases (e.g., quantitative easing) but the efficacy of such policies is starting to be called into question now that the U.S. Federal Reserve has embarked on an interest rate-hiking paradigm.

Are you concerned with inflation or interest rates rising soon?

This is the million-dollar question as all financial assets derive their value from a risk-free rate. Our base case is that long-term U.S. interest rates remain contained and will trade within a range for the foreseeable future.

Shorter term U.S. interest rates will likely rise at a measured rate in lock step with the increases of the Federal Funds rate over time. The reason we believe longer term rates will remain contained is because economic growth in the U.S. is slowing and U.S. demographics continue to gray (leading to incremental demand for bonds).

As we’ve pointed out in the past, this “flattening” of the yield curve starts to turn problematic typically when short-term rates move higher than long-term rates. We are still a long way from this occurrence.  What would be highly problematic, however, is if intermediate/long-term rates were to rise in a rapid manner over a short period of time.

Look for the next edition of our quarterly newsletter this summer, when it’s Marc Heilweil’s turn to share his expert insight on the key financial issues of the day — and points you’ll want to consider.

Authored By:

Gratus Capital is an SEC registered investment advisor. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request.  The opinions expressed are as of February 2017, and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities.  As with any investments, past performance is not a guarantee of future results. In illiquid alternative investments, returns will be reduced by investment management fees and fund expenses. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.

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You worry about them and work hard every day to provide for them, hoping they’ll grow up to be happy, healthy and independent adults. Yet as parents, we often scratch our heads trying to figure out how to teach our kids about money. In fact, some of us don’t talk with our children about money at all.

According to a recent T. Rowe Price® survey, 13 percent of parents surveyed said they never have financial conversations with their kids, while 59 percent said they only talk to their kids about money when their kids ask them about it.

Intuitively, we know it’s important to educate our children about the financial side of life, but what’s the best way to go about it? To answer this question, we looked to Gratus Capital’s Director of Financial Planning Kevin Woods, CFP® for some answers. To qualify his answers even further, we focused on children aged 11 to 25.

Before delving into the different age groups and their respective strategies, Woods believes it’s important that parents come to terms with the following two concepts. Once you do, you’ll have greater success helping your children become money-wise adults.

#1 – Understand Your Own Thoughts about Money

To help your children understand money, Woods says that you must first understand your own thoughts about money. “Every day as adults we make decisions that determine what we need and want,” said Woods. “This drives our lifestyle choices, including the cars we drive, the jewelry and clothes we wear, the house we own and all the extras that make us feel good

“However, living within your means and knowing what you can afford often starts with how we grew up and how our own parents helped us learn about discipline, sensibility, sacrifice, reward and goals when it comes to money. To educate your children, you have to come to terms with your own thoughts and expectations regarding money. Only then can you teach your children how to lead financially fulfilling and responsible lives.”

#2 – Understand the Impact of a Digitally-Charged Generation

According to Woods, today’s children are part of a generation that rarely struggles to get what it wants. In fact, most have never had to make a major sacrifice. Instead, many of today’s children primarily understand what makes them happy and how to get immediate gratification.

But why?

Because now more than ever, today’s generation of children are being highly influenced by products and services that promise to make them happy. Search engines are tracking your children’s behaviors and creating advertisements that match their individual search history. This bombardment of highly-targeted and customized advertising enables today’s children to see the very things they want to buy repeatedly. Whether it’s Facebook, Instagram, Snapchat or another digital channel, most kids can’t escape digital advertising.

Digital influence aside, what can you as a parent do to help your children establish good habits about spending, giving and saving for the future?

Since your children’s needs, wants, and goals will change depending on their age, Woods suggests these money-wise parenting strategies for the following ages:

The Formative Years: Children Aged 11 to 18

Most children receive money for allowances, birthdays, holidays and odd jobs such as babysitting and mowing lawns. At this time of your child’s life, you should explain three financial concepts to them:

  1. How much to save.
  2. How much to give back.
  3. How much they’re allowed to spend.

Woods suggests that children save no less than 20 percent for future needs, such as college, buying a car or attending a concert. He’s also a strong charitable giving advocate and recommends teaching children now about setting aside money for the sole purpose of giving back. He recommends five to ten percent be set aside for giving. The rest of the money should go toward what your child wants today – Starbucks, trips to the mall, etc.

Talk More to Bring Goals to Life

It’s very important to talk with your children throughout the year about their saving, spending, overall needs and wants, as well as their long-term goals. Woods suggests that parents have no fewer than four comprehensive financial conversations per year with their kids, and ideally 12. The more conversations you have, the more you help by reminding your children about their goals and checking in to see if they’re on target to accomplish them.

Spend More Time Together by Opening a Joint Account

Starting at age 11 and up is a perfect time to start buying some shares of stock or open a mutual fund. The key is for you and your child to establish what your child’s ongoing contribution goal will be. Over time, as your child sees his or her savings grow, this will instill the encouragement to save even more. This account also becomes one of the key financial conversations you’ll have throughout the year.

The Budgeting Years: Children Aged 19-25

Financial conversations between you and your children will vary greatly at age 19, perhaps even starting a bit younger. The focus now turns to budgeting, says Woods. For children who go off to college, Woods recommends that you and your child establish a budget for both their everyday and monthly needs. They’ll have fixed expenses, such as food and housing; however, they’ll also have variable expenses including entertainment, weekend traveling with friends, etc.

A monthly amount of money allotted to your child strengthens their decision-making ability surrounding how to make money last.

Many savings apps can be quite useful in helping your son or daughter to budget more responsibly. PCWorld has provided a nice roundup of budgeting apps for tracking savings and spending.

What’s more, Woods recommends that your child have a summer job and be solely responsible for saving no less than the money needed for the extra spending they may want throughout the school year and summer.

By allotting a monthly college budget and instilling upon your student that he or she is responsible for the extra spending they desire, when your child graduates college, they will have built a foundation for knowing how to live within an established budget.

Watch Out for Credit Card Magnetism

According to a recent Experian College Graduate Survey Report, one in five of the college students surveyed gives their college an F grade on preparing them to understand how credit works. What’s more, of those surveyed, 58 percent have a credit card and had the following personal experiences: 33 percent made a late payment, 31 percent maxed out a card, 23 percent had a card declined, and 15 percent missed a payment.

Given these statistics, it’s imperative that parents and their college-age children maintain open and ongoing communication about their child’s credit card usage. Like most financial vehicles, credit cards have their pros and cons. However, as with any effective financial tool, it needs to be managed, says Woods.

Beware the Taxman

When your adult child starts their first professional job, it’s very important that they understand taxes and how to manage what is left over. Too often, young adults forget to take taxes into consideration within their saving and budgeting planning.

Woods recommends that parents encourage their adult children to pursue four positive financial habits:

  1. Contribute 10 to 15 percent of their newly-found income to their company’s 401(k) or a similar retirement plan. If their company doesn’t have a retirement plan, which can be true for many small businesses, then contribute to an Individual Retirement Account (IRA).
  2. Make a list of monthly expenses to determine how much is available to afford rent, such as mobile phone, gas, car payments, food, etc. Additionally, there are new expenses, such as auto and renter’s insurance, that need to be accounted for.
  3. Establish a second savings or investment account, in addition to a 401(k) or IRA, and contribute to it each month.
  4. Set all savings and investment contributions so that the funds are deposited automatically, alleviating monthly decision-making around surplus income and increasing the likelihood the money is saved.

In Closing

It’s been our experience at Gratus Capital that parents who start educating their children about money during their formative years, such as talking about the costs of operating their home, including the mortgage, property taxes, electricity, heating and so on, help their children go on to be far more money-wise and successful simply due to the open dialogue between parent and child about life’s financial responsibilities and expectations.

At Gratus, we’re financial life counselors who advocate not just for your strong financial future, but that of your child’s. If you have any questions about your financial future, or that of your child’s, please contact us. Finance, budgeting, and investment management are just the beginning of our expertise.

Authored By:

The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.

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In the first quarter of 2017, the bull market seemed unstoppable. The Dow Jones Industrial Average soared past 20,000 and closed at all-time highs on 12 consecutive trading days. The Nasdaq Composite gained almost 10% in three months.1

An eight-year-old bull market is rare. This current bull is the second longest since the end of World War II; only the 1990-2000 bull run surpasses it. Since 1945, the average bull market has lasted 57 months.2

Everyone knows this bull market will someday end – but who wants to acknowledge that fact when equities have performed so well?

Overly exuberant investors might want to pay attention to the words of Sam Stovall, a longtime, bullish investment strategist, and market analyst. Stovall, who used to work for Standard & Poor’s and now works for CFRA, has seen bull and bear markets come and go. As he recently noted to Fortune, epic bull markets usually end “with a bang and not a whimper. Like an incandescent light bulb, they tend to glow brightest just before they go out.”2

History is riddled with examples. Think of the dot-com bust of 2000, the credit crisis of 2008, and the skyrocketing inflation of 1974. These developments wiped out bull markets; this bull market could potentially end as dramatically as those three did.3

A 20% correction would take the Dow down into the 16,000s. Emotionally, that would feel like a much more significant market drop – after all, the last time the blue chips fell 4,000 points was during the 2007-09 bear market.4

Investors must prepare for the worst, even as they celebrate the best. A stock portfolio is not a retirement plan. A diversified investment mix of equity and fixed-income vehicles, augmented by a strong cash position, is wise in any market climate. Those entering retirement should have realistic assessments of the annual income they can withdraw from their savings and the potential returns from their invested assets.

Now is not the time to be greedy. With the markets near historic peaks, diversification still matters, and it can potentially provide a degree of financial insulation when stocks fall. Many investors are tempted to chase the return right now, but their real mission should be chasing their retirement objectives in line with the strategy defined in their retirement plans. In a sense, this record-setting bull market amounts to a distraction – a distraction worth celebrating, but a distraction, nonetheless.

At Gratus, we provide sound asset allocation advice, from determining each client’s initial allocation (“getting it right”) to ongoing strategic asset allocation (“keeping it right”).  We offer our clients balanced and comprehensive investment advice, complete objectivity and a personalized investment strategy. We apply a value-orientation (absolute not relative) to all facets of the investment decision-making process. This approach informs both the asset class and underlying strategy decisions in asset allocation construction.

Authored By:

Gratus Capital is an SEC registered investment advisor. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request.  The opinions expressed are as of April 2017 and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities.  As with any investments, past performance is not a guarantee of future results. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.  All indices are unmanaged and are not illustrative of any particular investment.  This article was prepared by MarketingPro, Inc. This information has been derived from sources believed to be accurate. This article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice.  Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.


1 – [3/31/17]

2 – [3/9/17]

3 – [4/3/14]

4 – [4/3/17]

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Dedicated to helping others in our community, the Gratus Team partnered with Classic Cadillac to host a Make-A-Wish® granting party for Paxton, a 6-year-old boy battling a life-threatening brain disease. Paxton has been in and out of hospitals his entire life.

His wish: to go to Disney World and to become a Jedi Knight. Paxton already knew that he was going to Disney. However, what he didn’t know was that he’d be spending the day being trained as a Jedi by the Gratus and Classic Cadillac teams.

May the Force Be With You Paxton

Paxton’s wish party began with him being driven in a limo to the Cadillac dealership with two storm troopers as his drivers. Upon arrival, the two teams greeted Paxton dressed as Star Wars and Disney characters. We then proceeded to teach him Jedi and lightsaber moves he can use to guard peace and justice in the universe.

Our team left the party humbled by seeing so much courage exhibited by a young boy facing such a serious illness. We are truly inspired, and now possess a deeper understanding of how a granted wish can change everything in a child’s life by instilling hope.

According to the Make-A-Wish Foundation, one wish is granted every 34 minutes, and all wishes are granted by volunteers. The Gratus Team was proud to partake in such an important life event, and hope we helped Paxton to find even more courage so that he may conquer what lies ahead for him.

For More Information

Volunteering builds closer bonds, improves health and creates a sense of purpose. To learn more about Make-A-Wish volunteer opportunities, visit

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March 2017 Update: Dallas We've Had a Problem

“Houston, we’ve had a problem here.”  – Jack Swigert (Apollo 13 astronaut)

It was April 13, 1970, and the Apollo 13 mission to the moon was approaching the point at which the lunar lander was preparing for descent.  All of a sudden, an oxygen tank exploded which crippled the service module and effectively aborted the mission.  It was only after great effort and sacrifice that the crew of Apollo 13 was able to return the spacecraft safely back to earth.  In many ways, we believe that the Apollo 13 mission is a useful metaphor for the state of the US pension system.

What does Apollo 13 have to do with the pension system, and why should you care?  Just substitute “Dallas” for Houston and the metaphor will translate well.  For those that haven’t been watching what is happening in the city of Dallas, there’s reason to be interested…..especially for municipal bond investors.  Here’s a brief summary of what has happened.

The $2 billion Dallas Fire and Police Pension (DFPP) Fund finds itself at ground zero of the brewing pension issues on the horizon.  Essentially, DFPP made some bad real estate investments on behalf of its pensioners in the mid-2000s to include Hawaiian villas, Uruguayan timber and undeveloped land in Arizona.  These poor investments caused the pension fund to incur average annual losses of -1.5%/yr for the last five years, as opposed to the assumed return of 8.5%, to cover promised benefits.  These losses created a ~$7 billion shortfall that caused Moody’s and S&P to downgrade the credit rating of Dallas in early January.

Sensing that the pension was in crisis, many beneficiaries opted to take out lump sum distributions in lieu of the monthly payment.  This snowballing of fear caused ~$500 million in lump sum distributions in just the first few weeks of 2017, exacerbating the shortfall and causing the mayor of Dallas to halt all lump sum payments.  Now the city of Dallas/DFPP are in grueling negotiations to try and figure out where to go from here.

This brings us back to our original questions posed above:  What does Apollo 13 have to do with the pension system, and why should you care?  In short, we believe many investors are (1) overlooking large, unfunded liabilities, and (2) still relying on credit ratings and simplistic rules of thumb when making investment decisions on municipal bond offerings.  I’ll hear phrases like “I don’t have to worry about XYZ city because it’s a general obligation bond” or “this bond is AAA, so why would I be concerned”.  These are dangerous phrases to throw around.  In the case of Dallas, Texas, Moody’s has downgraded its general obligation (GO) bonds from Aa1 to A1 (three levels) in under 12 months due to pension concerns.  At Gratus, we approach a municipal bond portfolio with risk as a primary consideration.  To that end, below are a few considerations we keep in mind when constructing a municipal bond program.

1. Financial deterioration can happen quickly. Rarely is it the case that a municipality or state will jump from a high quality to low-quality bond overnight.  Yet, details are important to monitor.  One detail that we find useful is the rate of return (a.k.a discount rate) assumption being used by a municipal pension.  According to Piper Jaffray & Company, the median rate of return assumption being made by most municipalities is 7.75%.  In other words, the municipality is expecting the pension asset pool to earn 7.75% in perpetuity.  Obviously, this is far too high given where interest rates currently sit.  The problem, however, is more insidious.  If the municipality lowers its return assumptions, this increases the unfunded liabilities amount given that more assets are needed to generate the same return.  The table below illustrates this dynamic well. 

Discount Rate 7.6% 7% 6% 5% 4%
Total Liabilities ($tn) 4.5 5.1 5.8 6.6 7.5
Assets ($tn) 3.4 3.4 3.4 3.4 3.4
Unfunded Liability ($tn) 1.2 1.8 2.5 3.3 4.1

All this is to say, when interest rates were higher, there was more margin for error on investment returns.  Now with interest rates hovering around historically low levels, there is far less margin for error.

2. You can’t outsource your due diligence to a credit rating agency. While one would think companies providing insurance to municipal bonds have learned a valuable lesson in the credit crisis, we never rely on this insurance when making a municipal bond investment.  Certainly, the quality of municipal insurers has improved since 2008 with the entrance of behemoths such as Berkshire Hathaway, White Mountains Insurance and others.  Yet municipal bond insurance is often a reason I hear for not doing credit analysis under the idea that if Berkshire Hathaway is insuring the bond then it’s as good as an obligation of Berkshire.  Certainly, this will be the case longer term, but if an investor is relying on timely principal and interest payments as part of their income, any disruption (whether for a month or six months) to a payment can be difficult to endure.

3. Most municipalities display warning signals in advance of distress. As Wayne Gretzky once said, “A good hockey player plays where the puck is.  A great hockey player plays where the puck is going to be.”  Our thought on the current pension situation is simply to avoid investing in municipalities/states where the unfunded liabilities are large relative to the size of the pension and tax base.  Furthermore, to reduce the risk of a pension disaster, we can look at essential service bonds which have zero pension/benefit obligations.  An example of this would be a municipal bond whose principal and interest is derived from a utility bill or special purpose tax.  Good examples of municipalities that were displaying warning signals well in advance of bankruptcy were:  City of Detroit (2013), City of Stockton (2012), City of Vallejo (2008), Puerto Rico (2016).

Current municipalities flashing warning signals include the following:  State of Illinois, City of Chicago, Cook County, Marshall Islands, American Samoa, State of Connecticut, City of Hartford, State of Rhode Island, City of Providence, State of New Jersey, among others.

In summary, our point in publishing this article is not to scare clients into thinking that there is some action that needs to be taken; it’s merely to describe the new world order in the municipal marketplace.  In our opinion, rules of thumb can be dangerous.  As with the Apollo 13 mission, the problem is not terminal, but it’s pretty close to dire for certain municipalities.  Unless dramatic and swift action is taken at the municipal level to right-size pension obligations, there will be identifiable losers over the medium term:  bond holders and pensioners of the problem issuers.  We are (and have been) proceeding with caution in the municipal marketplace as we see certain geographies that could have problems in the future.

Post Script:  After I wrote the piece above I looked into the situation for union pension plans.  As it turns out, the first union pension plan declared bankruptcy (NY Teamster Local 707) earlier this year.  According to industry estimates, a further 200 union plans are on the brink of insolvency. 

Authored By:

The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.

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Welcome to Gratus Capital’s Quarterly Market Outlook.

Each quarter, our investment experts – Marc Heilweil, Senior Portfolio Manager, and Todd Jones, Director of Investments – weigh in on the current financial environment. They lend context to common areas of interest or concern, and hopefully spark new conversations between you and your Gratus advisor.

Here’s what Marc and Todd are talking about this quarter:

What are the reasons the market has reacted so strongly to President Trump being elected?

TJ: There are three primary reasons why the market has reacted so strongly to the recent change in our country’s leadership.

#1 – There are potential tax changes that have the ability to improve earnings by double digits. Therefore, the market is discounting in anticipation of favorable tax changes.

#2 – Anticipation of regulatory change is also adding to market discounting. For example, by reducing regulations on banks and other industries, such as energy or mining, these share prices have taken off dramatically. Some projects will likely be more accessible in the near future, such as drilling offshore near California.

#3 – The earnings recession is ending. For approximately the last 18 months S&P earnings were flat; however, we’re starting to see movement toward more positive returns.

Why are alternative investments important now in order to reduce risk in portfolios and provide a reliable return?

TJ: There are two key reasons why alternative investments are important right now. First, they offer diversification benefits that come from earning a return in a different way with no correlation to the equity or fixed income markets. Secondly, because both equity and fixed income markets are currently fairly expensive.

Bonds have been selling off post U.S. election on a global basis. Are bonds still a good investment to have in a portfolio? How is Gratus addressing the recent back up in yields?

TJ: Yes, bonds are still a good investment. They provide two critical components within a portfolio, specifically income generation and volatility dampening. Keep in mind that bonds and stocks don’t move in the same direction. Therefore, when equity markets are rapidly selling off, bonds help provide diversification.

Certainly there has been a notable move up in yields, which tends to push prices down. The way Gratus has addressed this, dating back as far as 2009, is by avoiding government bonds. They’re the most exposed to a changing interest rate environment. More recently, we’ve been gradually migrating away from fixed income investments and moving toward alternative investments in order to take advantage of lowering yields.

Will the US dollar stay strong throughout 2017 and how will this impact your investment decisions?

TJ: In the past two years, the US dollar has strengthened and has been a key macro variable in question. The reason why the dollar’s strength could be an issue is because of its impact on international earnings by U.S. companies. Specifically, the US dollar’s strength impacts foreign earnings. The degree to which earnings are impacted is the variable we’re watching closely, including how companies are adapting to the stronger dollar environment.

Keep in mind that when the dollar is strong it negatively impacts emerging markets’ currencies. This is the primary reason why we presently don’t believe in having emerging market exposure within our portfolios. 

Does the rise in global populism concern you as an equity or fixed income investor?

MH: For some time now I’ve been concerned about the rise in global populism. It’s quite understandable that the rapid rate of change has caused people to question whether their governments are actually looking out for them. There’s no doubt in my mind that governments haven’t shown adequate sensitivity to this concern and it’s caused people to question whether their government could have done more to control the rate of change. In particular, I’m very guarded about the outlook for the Eurozone. The populist candidate, Geert Wilders, appears likely to get a majority in the Netherlands and he advocates withdrawing from the Eurozone.

As with many of these upsets or changes, the breakup of the Eurozone may not be as damaging in the long term as current fears would have it. Relief from the Brussels bureaucracy may provide a stimulus to European economies, similar to how President Trump has unleashed some confidence in the American business community.

Health care seems to be a bad place to be since the ACA will likely get repealed. Why would we own it?

MH: Unfortunately the demand and the need for health care will not change. Whether it’s a minor illness or a more serious heart problem, we’ll need our health care system. Whether or not the ACA gets repealed in full or merely gets modified remains to be seen. In a stock market of very high valuations, the uncertainty over health care reform has created some attractive opportunities in that space. Very high-quality health care companies are discounting negative changes that may not occur.

For Example:

Pricing and competitive bidding for pharmaceuticals would have to be instituted by Congress. However, in the past they’ve shown no willingness to accomplish this. One of the benefits I’d like to see happen and is consistent with President Trump’s viewpoint is measures to ensure that other wealthy countries pay better prices for the inventive products of American pharmaceutical companies. Essentially, America has been subsidizing the research and development of medical devices and drugs while other wealthy countries, through their price controls, have not contributed. In fact, countries such as Japan and Germany drop the price of drugs on an annual basis.

President Trump and Congressional Republicans have talked a lot about lowering corporate tax rates. Has the rise in stock markets resulted from this, are companies really improving, or are we going back to “irrational exuberance”?

MH: Unquestionably the policies of the new administration are being viewed positively by the financial markets. Certainly there is a large discrepancy between the corporate taxes shown as paid for financial statement purposes versus the actual amount that is paid to the IRS. Therefore, while cleaning up the corporate tax situation is long overdue, and the lower stated rate currently thought to be 22% is a positive for small business, one must be humble in the face of the uncertainties in the current environment. Remember that when share valuations are very high the market becomes susceptible to unforeseen shocks.

What’s an investor to think about the stock market today?

MH: I think it’s important to concentrate on what can be known, and what’s knowable is analyzing businesses from the ground up. Remember that buying shares is buying a piece of an existing business. Ask yourself whether the business is well positioned within its marketplace and whether the culture and leadership are acting in the interest of all shareholders. What’s more, never forget to pay attention to the price that is paid for a share of the ownership of the business.

How can people follow up with you on these issues and any related questions?

TJ: I gladly welcome any follow-up questions or questions for next month’s commentary. Send them to

Authored By:

 Gratus Capital is an SEC registered investment advisor.  Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request.  The opinions expressed are as of February 2017, and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities.  As with any investments, past performance is not a guarantee of future results. In illiquid alternative investments, returns will be reduced by investment management fees and fund expenses. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.
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Save More Money for Retirement in 3 Easy Steps

According to a recent survey, one in three people has no retirement savings.1 Clearly, if you’re not feeling confident about your retirement savings, you’re not alone. As financial advisors, we believe that it’s never too late to begin saving for retirement. The key is to get started. Once you get past this initial hurdle, you’ll see your savings accumulate. To begin, first create a realistic household budget and savings plan.

To help you save more money for retirement, follow these three steps:

Step #1 – Determine what amount of money you can live within per month.

Notice that we said, live within. In order to effectively save more for retirement, you first need to define a budget. One that includes forgoing miscellaneous purchases and freeing up additional funds for your retirement savings.

Keep in mind that most people spend and then save what’s left over. The problem with this approach is that there’s typically very little left over, if anything at all. Therefore, a key budgeting step is to first determine how much you need to save each month.

By using a retirement calculator, you can get a better understanding of how much money you need to save in order to afford retirement based upon your projected time frame goals.2

Step #2 – Ask yourself: Where is my money going?

If your savings aren’t adding up fast enough to meet your projected retirement timeline, then the next step is to ask yourself: Where is my money going?

To answer this question, try using an automated tool that helps track spending. For example, Mint is a program that pulls all your financial information into one place so you can see your entire financial picture. Once you have a better understanding of where and what you’re spending money on, you can make proactive savings adjustments.3

Step #3 – Make spending cuts and redirect the funds back into savings.

Before you start cutting, be sure that you’ve outlined your savings goals and projected retirement timeline. By having goals underscored by reasons, it’ll be easier for you to cut expenses.

Good savers are typically individuals motivated by personal goals.

Contemplating where to cut spending? Try looking here:

  • Travel & Vacations – Do you really need to take your family to Disney World this year? Instead, how about a weekend in the city. Taking advantage of local tourist destinations is a nice alternative to expensive vacations – and Atlanta certainly has a lot to offer!
  • Home Repairs – Spend when it’s really Small DIY jobs can often spiral into costly home renovations. Plan ahead for major home repairs by saving in advance. In the meantime, focus only on the projects necessary to the function of your home. Décor preferences change with the season, and it’s worth waiting it out until you’ve properly budgeted for major updates.
  • Dining Out – It’s true, packing a lunch slows you down getting out the door in the morning. What’s more, it’s tiring coming home after a long day at work and then needing to cook dinner. Yet, there are tremendous savings to be had if you were to simply cut back on your dining out. CNN Money found that you could save as much as $207,598 by skipping two restaurant meals a week over a period of 40 years.4 How about limiting a night out to once or twice a week?
  • Coffees-To-Go – Those lattes sure are delicious, and at $5+ each, they ought to be. In fact, if you enjoy one each day on your way to work 49 weeks out of the year, that’s approximately $1,225 a year in lattes. How about limiting yourself to one or two lattes per week?

Many people believe they need a large income in order to save effectively for retirement. This isn’t true. The key to saving is to monitor your spending habits and automate your savings.

If you’re serious about wanting to save more money for retirement, then download our latest complimentary guide: Practical Steps to Fix 3 Fatal Flaws in Your Financial Plan. Learn long-term savings strategies to help you achieve your retirement goals.


Authored By:




The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.

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This guide outlines 3 fatal flaws in your financial plan and identifies steps to help you overcome each one.

These flaws include:

  1. Failure to budget and save
  2. Failure to keep budgets real
  3. Failure to adjust and rebalance financial portfolios

What typically precedes an enjoyable and financially comfortable retirement is a well-defined budget and savings plan. Learn simple steps to help you accumulate additional long-term savings and strengthen your financial plan.

Learn to grow wealthy over time.

Click here to download the guide now.


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February 2017 Update - New President, New Outlook_Gratus

“It’s tough to make predictions, especially about the future”.  – Yogi Berra

“Economists are often asked to predict what the economy is going to do. But economic predictions require predicting what politicians are going to do – and nothing is more unpredictable.”  – Thomas Sowell

At this juncture, we continue to believe that making financial market predictions is a dangerous business.  Not only is there economic uncertainty relating to the fact that we are now in our eighth year of expansion during this cycle, but we also have obvious political risks percolating around the world.  To that end, political uncertainty now inhabits the White House with aspirations of undoing most of what has been done over the last eight years.  This US-specific political risk is one of many global political risks that stems from burgeoning nationalist movements in Western Europe and elsewhere.  These nationalist movements have the potential to be disruptive to economies over the short term.

Why does political risk matter now?  In our view, it’s simply because outcomes in many western economies are now even more difficult to forecast.  In other words, recent historical norms around free trade (TPP/NAFTA), immigration policy, and military unity (NATO) are coming into question.  In the spirit of a New Year and new president, we thought we’d collect and opine on President Trump’s priorities for 2017.

  • Roll back “regulation” because there is too much regulation in all areas of business

Trump’s Transition Team (TTT) has indicated that upwards of 75% of all regulation is unnecessary.  Financial markets are betting that a large portion of Dodd Frank gets rolled back.  This can be seen in the performance of most financial sector companies, which have responded very positively post-election.

INVESTMENT IMPACT:  Likely beneficiaries of reduced regulation would be heavily regulated sectors like energy and mining, as well as the financial sector.  Recent share price movements in metals/mining/energy shares certainly indicate it may be easier to mine/drill in more ecologically sensitive areas than previously thought.  Interestingly, nuclear companies are performing well, with the idea that no one energy source is favored over another.  Until recently, nuclear has been discouraged due to the nuclear waste disposal issue.

  • Overseas cash repatriation.

The idea is that US companies would be able to bring their overseas cash back to the United States at a low tax rate.  This proposal is fairly straightforward and has a high likelihood of passing through Congress without much obstruction.  Repatriation would give corporations access to much-needed liquidity in the event they decided they wanted to pursue M&A activity, increase share repurchases or increase dividend payments.

INVESTMENT IMPACT:  The investment impact of this policy would be relatively limited if we use the template of the first overseas cash repatriation that occurred in 2004.  Under that template, cash that came back was mostly paid out in dividends….not reinvested in the company.  Furthermore, overseas earnings that are being converted back into US dollars could cause the US dollar to move higher, which would crimp future earnings from those same overseas subsidiaries and, potentially, kick start the next recession. 

  • Reduction in tax rates at both the individual and corporate levels. 

There’s still a lot of distance to close within the Republican ranks as President Trump and Speaker Ryan have publicly proposed plans that are different.  Both men have proposed unique plans for corporate taxes as well as individual taxes.  The key is that they both believe something needs to be done.  This area of tax reform has, in my opinion, the highest possibility of getting Congressional approval.

INVESTMENT IMPACT:  As tax reform legislation works its way through the approval process, equity markets in the US will likely respond positively.  Goldman Sachs estimates that tax reform alone could add up to 4.8% in earnings per share or roughly $6 to 2017 S&P 500 earnings.  The downside, I believe, is that most of this benefit has been priced into equities already as exemplified by the move in small company stocks since election day.

  • Repeal and replace the Affordable Care Act (ACA).

President Trump has already issued an executive order to minimize the ACA’s impact at both the state and federal levels.  The US House of Representatives and the Senate have initiated legislative proceedings to defund the ACA at the same time.  It looks like this repeal and replace is the highest priority for most Republicans in D.C. right now.  The problem, of course, is that even with 3+ years of time to come up with a transition plan for the ACA, there is still no cohesive legislative solution to fill the ACA’s void.

INVESTMENT IMPACT:  It’s still too early to tell, but clearly there will be segments of the healthcare complex that stand to lose if the ACA is repealed without any solution (hospitals, pharmaceutical companies, etc).  Outside of healthcare, I don’t see much by way of immediate market impact until more details are known.

  • Massive infrastructure spending bill to rebuild America.

Again, nothing is really new here as both candidates Trump and Clinton had infrastructure spending proposals.  Clinton proposed an Infrastructure Bank while Trump proposed opening up US infrastructure to public private partnerships (PPP).  PPPs are a unique way to raise private capital for public projects but, effectively, these new PPPs act as new taxes on people that use those facilities.  Further, most infrastructure spending would get pushed down to the state/local levels.  From the time a funding measure for infrastructure would be passed to seeing shovels in the ground could take as long as 2 years given the permitting, environmental, and governmental approval process.

INVESMENT IMPACT:  Likely very little impact in the first four years of the Trump presidency.  To fund the level of infrastructure being tossed around (~$1 trillion), a lot of new debt would need to be issued and absorbed by the markets.  The Federal Reserve could buy that debt directly, but this may interject new risks to the financial system if the bond mark loses faith in the Federal Reserve.  On the positive side, the sheer scale of the program would likely lead to higher levels of employment which could have a positive effect on consumer sentiment thereby providing support for risk assets.

In summary it would appear, based on our initial analysis that much of what is being proposed above as stimulus to the economy has been accounted for in current market prices.  This makes intuitive sense as equity markets typically function with a 6-12 month forward-looking discount mechanism.  (For example, while the S&P 500 bottomed out in March of 2009, S&P 500 earnings didn’t start their upward movement until August/September of 2009).  Further, most of the above has to actually occur for the equity market to maintain its current valuations!  Said another way, don’t get pulled into the hyperbole of the 24-hour news cycle, and keep your focus on the long term.

Authored By:

The above article is intended to provide generalized financial information; it does not give personalized tax, investment, legal, or other professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other matters that affect you or your business.

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