here - Narwhal Capital

First Quarter 2015
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Market
Volatility
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Investment
Tenets
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Who Needs
Conventional
Investing?
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Same Whale,
New Website
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Narwhal News
We talk a lot about market volatility and its impact on portfolios. But often, as was the case in
the first quarter of 2015, the “take home” result of returns dilutes the impact of volatility and
what really happened. While one would have been hard pressed to escape the dramatic
headlines surrounding oil, Fed announcements, unemployment data and bad weather reports
last quarter, it’s still easy to overlook the totality of the market’s movements over the first three
months of 2015.
Looking at simplified data does little to capture matters accurately. The S&P 500 opened the
year at 2,058.90 and closed the quarter 8.99 points higher at 2,067.89. Sounds pretty
uneventful, does it not?
In terms of the cumulative result of intra-day movements, perhaps this was a boring quarter.
Over the course of 61 trading days the market only “moved” 8.99 points. But simply looking at
the starting point and the finishing point is a short-sighted take on what transpired. Consider
this illustration:
In 2017 the Atlanta Braves will begin playing home games at SunTrust Park. Though this move
is controversial on multiple levels, I have been able to ignore social, political and financial
ramifications and focus on one piece of very good news. The new ballpark wi ll be nine miles
from Narwhal’s office. That’s fantastic for me.
As you can see, I will soon have a very direct path to watch the Braves play.
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Disclosures
But, I could also start off at the office and tour the Southeast en route to SunTrust Park.
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Market Volatility (Cont.)
I could leave the office and head north on Interstate 75. Along the way I could see Rock City in
Chattanooga and catch a country music show in a smoky honky tonk in Nashville. Then I could
head into the Blue Grass State and pick up some of my favorite bourbon from Willett Distillery
in Bardstown before heading west and catching I-75 back down to Knoxville where I’d catchup
with my older sister and her husband. No trip to East Tennessee is complete without some
scenic views, so I could head west on Interstate 40 before making my way south using a more
rural route. Eventually, I’ll end up back in Metro-Atlanta and settled at SunTrust Park. I’ll still
want that over-priced frosty beer in a plastic cup. Peanuts and Cracker Jacks are a given.
If we look at the beginning and ending points, both of these trips would be identical. Each
would start at Narwhal’s world headquarters in Marietta and end about nine miles away at the
new home of the Braves.
But I’d be remiss to say that the trips are alike by any other measure. And to scale, those two
trips are reflective of what the stock market did during the first quarter of 2015.
Sure, the price of the S&P 500 only appreciated 8.99 points (the nine-mile direct route to see
the Braves in the first illustration). But the market moved a total of 898.85 from same-day open
to same-day close points over the course of 61 trading days (the 900-mile trip through Tennessee
and Kentucky and back detailed above).
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Put another way, every point of net market gain came at the cost of more than 99 total market
point movements. In other words, this wasn’t a two steps forward / one step backward scenario. It
was a 50 steps forward / 49 steps backward kind of deal.
Market Volatility (Cont.)
So even if the end result wasn’t tangibly rocky, explosive, unsettling or [insert distressing
adjective here] over the finite period beginning in January and ending in March, the volatility
still took its toll. We still traveled through three states to get to a Braves game in the same
county. We still took nearly 100 steps to move one single stride.
A few more notes on this exhausting activity:
An 8.99-point move could have been achieved with an average movement of .147 points per
trading day. Instead, it was achieved with an average movement (positive or negative) of 14.74
points per day.
More than 55% (34 of 61) of trading days saw the S&P 500 move more than 0.5% from open
to close. Nearly one-third (19 of 61) of trading days saw movements in excess of 1%.
If this quarter had been a March Madness basketball game and the opening tip occurred at the
market’s open on January 2 nd, then the following 3 months would have seen fourteen lead
changes (yellow arrows in the graph below) between the “Up” and the “Down” cumulative
market teams—and that’s just including end of day data.
However, the most noticeable trend, as demonstrated by the analysis and charts above, was
chaos. And the only antidote for such prolonged volatility—and it’s still very much a factor—is
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discipline and forced order.
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The “down” days were plentiful and clustered in posting four different stretches of threeconsecutive negative outings as those streaks accounted for 15 of the market’s 35 down days.
But the “up” sessions were powerful, posting an average intraday breakthrough of 0.86% across
26 positive trading days.
Market Volatility (Cont.)
Indeed, making a market call on any of the peaks or valleys of the first quarter would have
already proved foolish.
Three consecutive sell-offs to open the quarter presented a false-trough as the January 6 close at
2002.61 was bested (or, in this case worsted) on three occasions:
 January 15 close: 1,992.67
 January 28 close: 2,002.16
 January 30 close: 1,994.99
Similarly, the S&P may have hit a high on March 2nd when it bounced up to a 2,117.39 close
before falling more than 77 points over the following seven trading days. But within seven more
sessions the market was back over 2,100 and at the time of this publication (April 20) the S&P
500 is hovering around that arbitrary landmark and climbing.
As Aziz will discuss in the next article, we’re not market callers. We’ll gladly live and die by strict
adherence to boring asset allocation disciplines. By doing so we hope to limit volatility among
client portfolios rather than contribute to it with swiftly sweeping buys or sells.
But by diversifying both across and within asset classes we are positioning portfolios for a time
when the market may be a little bit less volatile and a little more direct in its trajectory. More
bluntly, we’re preparing portfolios to protect against a true market pull back. Simultaneously we
continue to focus on individual stock selection on the equity front to take advantage of undervalued opportunities while looking for reasonable yields and shorter durations in the bond
space to avoid being trapped in a rising interest rate environment.
--Andrew
Narwhal Investment Tenets
Editor’s note: Last month Aziz Pirbhoy and Matt Burton published thoughts on the Fed, interest rates,
market volatility and actions by Narwhal. This article continues upon these topics with an emphasis on
application. For a copy of that original market note please contact Sarah Haynes
([email protected]) or visit NarwhalCapital.com.
After getting a more intimate feel for the Fed, interest rate policy and the resulting market
volatility, you might ask how Narwhal has approached the management of your investment
portfolio and if we have any further alterations we’d like to introduce in light of these
unknowable scenarios. While these are fair concerns to have, we believe our long emphasized
investment philosophy provides an honest answer (paraphrased):
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Our investment philosophy consists of an empirically proven approach to portfolio management that stresses
a long-term, value-orientation and diversification within and across asset classes.
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Investment Tenets (Cont.)
Further, we have no plans to alter our course as we believe that our existing approach is how real
investment success is achieved, rain or shine, over long periods of time. This may not come as a
surprise to some, but it may be a disappointment to others that associate “doing something new” with
the expectation of an improved outcome. Nonetheless, we’ve included an expanded discussion of the
tenets underlying our investment process as uncertain times can often spark the human inclination for
flight – a great instinct to have if you’re being attacked by a bear, but of little value when striving for
long-term investment success.
First, at Narwhal individual investment decisions are made with a value orientation. In essence, we
aim to buy securities that we view are trading in the marketplace at prices below their intrinsic value
and sell when the opposite is true. We arrive at our conclusion of intrinsic value through careful
research and analysis of a particular asset or company’s fundamental metrics such as Price to Earnings,
Free Cash Flow Yield, etc. We try to own what’s cheap and sell or trim what’s expensive. This often
results in the purchase of less “sexy” securities (i.e. Microsoft vs. Salesforce.com) that exhibit a more
favorable risk/reward profile.
Second, our investment decisions are made in the context of a long-term perspective or investment
horizon. While that definition can vary based on your individual circumstances (i.e. needs, goals and
risk tolerance, and other factors we take into consideration when constructing your portfolio), at
Narwhal our security selection is generally based on a time horizon in excess of 10 years. The core
benefit of maintaining a long-term perspective is that it allows us to acquire and hold securities
without being at the whim of the market’s day-to-day fluctuations or the latest fad. Rather, positions
are more subject to the fundamental metrics underlying an individual security’s intrinsic value. Time,
in the words popularized by Mick Jagger, is on our side.
Finally, we strive to construct and maintain your investment portfolio with full diversification across
and within individual asset classes. Diversification is often observed as the Holy Grail of good
portfolio management as it reduces the risks particular to an individual security and leaves the
portfolio’s overall risk less dependent on an individual asset. Further, diversification also reduces the
correlation of returns across asset classes. Logically and from a risk management standpoint, this is an
appealing concept. We’ve included a basic example of diversification below (those with advanced
degrees from “The School Of Market Knocks” may choose to quickly review, but it never hurts to
cover the fundamentals).
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Let’s assume your total liquid wealth is $100,000, and you can only invest in the stock market through two
investment choices: 1.) place the $100,000 in one individual stock that you’re convinced is a winner; or 2.)
spread the $100,000 equally across a large number (50+) of individual stocks that you similarly believe are
winners. The payoffs are substantially different from a risk and reward perspective. In option 1, the stock
could prove to be a winner and you can double your money to $200,000 (100% return) or at the other
extreme the company could go bankrupt and your stock as well as your wealth would diminish to $0.
While with option 2, the probability of a extreme upside is significantly lower the chance of extreme
downside is also much lower. Think of it this way: The average return for all 50 stocks would need to be
100% to double your money (highly unlikely) and the average return of all 50 stocks would need to be 100%, for your wealth to go to $0 (equally unlikely). So thinking even more rationally, diversification
protects you in case one of your 50 stocks does go bankrupt. If each of the other 49 positions were
constant, the bankruptcy of a single company would yield a loss of just 2%.
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Investment Tenets (Cont.)
Needless to say, your investment portfolio at Narwhal has been purposefully constructed with
adequate diversification and your individual circumstances (i.e. your investment goals, income
needs, and risk tolerance) in mind.
Additionally, the tenets underlying our investment approach help to avoid the trap of trying to time
the market. We resist the urge to materially deviate from your Investment Policy Statement’s target
capital allocation ranges for a particular asset just to chase expected outperformance. In our view,
this is a flawed strategy steeped in hope as the consistent timing of favorable entrance and exit of a
particular asset class require a high degree of luck to offset the increased risks and costs (i.e. trading
costs, loss of tax deferrals on capital gains, etc.). Further, empirical evidence confirms market timing
to be a random, losing proposition over longer periods of time for the vast majority of investment
managers. That said, we’ll keep you invested, but know that our mandate of diversification and
careful asset selection is on your side and should triumph over long periods of time.
In total, the trifecta of a value-oriented, long-term investment approach and adequate diversification
structures a portfolio with an adequate balance of risk and reward to grow and preserve your hardearned financial wealth.
--Aziz
Unconventional Investing
With the 1st quarter wrapped up we pause to take a deep breath and as we do every quarter, take score.
Undeniably we are anxious to see if we are tracking the market or better yet, beating “the market” and
yet in moments of true clarity we ponder the frailty of such an exercise. Think of it for a moment – to
freeze in time some 90 or 91 days, comparing our activity and performance against the collective and
somewhat random force of the world’s investment markets. But we do it.
I digress – to wit our performance this first quarter was officially not so hot, nor was it too cold. Within
the context of those 3 months we (overall) trailed the S&P 500 with our equity returns while generally
matching the market with our fixed income returns, whether it be in tax-exempt or taxable paper.
Are we concerned? As concerned as the next rational investor. But we are not distraught. If anything,
my career in this pursuit has given me a certain perspective, a perspective that continues to get sharper
and sharper with experience. Simply put: we should not fear the short term underperformance or
dislocation from markets. Long term, superior performance means doing something different from the
market. Diversion is a necessary component.
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My greatest fear is not under-performing the market for a short time period, it is losing the courage to
look wrong temporarily while holding true to our convictions in the face of short term disruptions.
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Unconventional Investing (Cont.)
Howard Marks, chairman of Oaktree Capital Management wrote last year, “Unconventional behavior is
the only road to superior investment results, but it isn’t for everyone.”
While I agree with the spirit of his statement I think that the implication will be missed by many
investors, particularly young investors who interpret the term “unconventional behavior” as tacit
approval for crazed, concentrated, levered, and/or esoteric investments driven by tidal patterns, Super
Bowl winners, Presidential cycles, pollen counts or whatever the “new” strategy happens to be on the
Internet and CNB-Blah-Blah.
For me, one of the elements of unconventional behavior is the willingness to stay the course with a
discipline that works over time – to do the basic “blocking and tackling” of portfolio management on a
regularly scheduled basis, to make small adjustments in asset allocations as asset class valuations shift, to
seek out opportunities that not only provide appropriate upside but also have a certain margin of safety
on the downside. Indeed sticking to our investment tenets, as outlined by Aziz in the previous
article, is unconventional in today’s investment world.
Alas, we press on into the second quarter. We review our holdings, we make adjustments when the
investment no longer fits or works for you, our clients. Make no mistake about it, we hope for short
term performance, but we dream for long term (think years, many years) performance that is truly
superior, objectively and relatively to both markets and risks.
--Matt
Same Old Whale, Brand New Website
Editor’s Note: This article appears as a blog post on NarwhalCapital.com.
If something’s worth doing, it’s worth doing right. In this case, it was worth doing slowly (and—
we think—methodically!).
More than ten months ago we reached out to a web design firm. We weren’t looking for ideas
so much as we were looking for execution upon ideas. But we needed help.
As you might guess, our office of investment advisors, accountants and compliance gurus isn’t
necessarily the most aesthetically creative or technologically edgy bunch (hence the first major
website overhaul in five years). But we do know what we don’t know. And we don’t know web
design.
We asked Colossus Designs for insights on how to do three things:
Now, a mere 300-some-odd days later we’ve done just that.
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1. Reduce content without losing meaning.
2. Promote and highlight blog posts and original content.
3. Enhance connectivity.
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New Website (Cont.)
We cut out the arduous minutia and industry jargon geared towards institutional investors and
replaced it with a more tangible description of what we do. We reduced the quantity of content and in
doing so we created a meaningful narrative.
Further, as you’re already seeing this new design showcases blog posts and allows us to communicate
more consistently with clients and the outside world. We look forward to sharing market insights,
investment theories and anecdotal discussions several times each week.
We hope that commentary won’t be a monologue but rather the foundation of many dialogues. As
such, we’ve increased connectivity with the website by offering direct links to employee LinkedIn profiles
and the opportunity to automatically receive updates from the firm in your inbox.
While our investment processes and philosophies remain unchanged, we do believe the updates to
NarwhalCapital.com are consistent with our ongoing commitment to improving the client
experience.
So poke around, see what’s new, subscribe to the blog and come back often.
--Andrew
Quarterly Narwhal News
John Holt, Narwhal’s Chief Compliance Officer, celebrated his 30 th birthday in very non-compliant
ways this January.
Congratulations are in order for Dean Wardlaw and the Narwhal Tax and Accounting Department
for making it to and through the dreaded April 15 deadline.
Equally impressive, Scotty Valiani (Narwhal’s intern and Chief Grocery Officer) won the company’s
annual March Madness Contest despite a last-place ranking at the end of the opening round.
According to ESPN, fewer than 4% of all submitted brackets predicted a final matchup between
Duke and Wisconsin. Scotty was part of that elite group.
Also this quarter, Andrew’s wife gave birth to their first child—a 9lb., 3 oz. baby girl named Hayden
who nurses described as having “rolls on top of rolls.” Hayden enjoys eating, sleeping, pooping and
watching ceiling fans.
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In other family news, Matt’s son Luke broke four Davidson College swimming records and one
Atlantic 10 Conference record in February. Not to be outdone, Matt’s other son, Will, was recently
elected Junior Class President at Mount Paran Christian School.
And on a serious note, Glenn Moyer, one of Narwhal’s youngest clients, safely returned from
deployment. While he was away he sent us a flag that was flown over Kabul on the last day
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operations in Afghanistan. If you’re near our office, come check it out. We are humbled and grateful
for Glenn’s service.
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Disclosures
All data in all articles gathered via Bloomberg Terminal.
We certify that the opinions and predictions set forth in Narwhal Capital Management
publications are, for better or worse, our professional beliefs at the time of publication. We
are not under duress or pressure from any of the corporate entities mentioned, nor do we
intend to do business with them on the investment banking or advisory side of things. Nor
is this a solicitation or inducement to take action, whether buying or selling, based upon the
opinions presented. Again, this publication is a summarization of our professional beliefs
and actions that have occurred in the past. We are not “selling” nor attempting to convince
the reader of any one particular course of action.
Although we are investment advisors, our publications are not to be construed as
investment advice. Quite frankly, this publication is a snapshot of our research and
opinions. We strive to be as impartial, insightful and accurate as possible. We do base our
opinions, analysis, and calculations on information and analysis that we believe to be
reliable, but we cannot guarantee that they are either accurate or complete. We may change
our minds about any item mentioned and we will not necessarily update them in print. We
can guarantee that our research and opinions will sometimes be flat out wrong. This may
be from subjective blind spots, mistakes, ignorance, uncertainty of predicting events, or
emotional bias. However, we prefer that our predictions/opinions/ research be proven
right 100% of the time, and that the stocks our clients own go up, not down, therefore you
can assume some level of self-interest and “hope” is present in this and all future
publications.
The securities presented in this newsletter are examples of the securities held in Narwhal
portfolios and may not be representative of the current or future investments of Narwhal
portfolios. You should not assume that investments in the securities mentioned in this
newsletter were or will be profitable. We will furnish, upon your request, a list of all
securities purchased, sold or held in the portfolio referred to in this newsletter during the
12 months preceding the date of this newsletter.
Narwhal Capital Management, LLC, or one or more of its officers or employees, may have a
position in these securities, and may purchase or sell such securities from time to time.
Finally, we must disclose that PAST PERFORMANCE DOES NOT GUARANTEE
FUTURE RESULTS.
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© Narwhal Capital Management, LLC
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