Accretive Q4 2020 Client Letter

Dear Clients and Friends of Accretive,

Happy New Year!   At the end of the fourth quarter, Accretive managed approximately $168 million for clients on a discretionary basis.  As a result, we are waiving 5% of our management fee for the first quarter of 2021 under our Client Alignment Program™ (CAP).  

You may notice that 5% is a higher percentage than the 2.5% that we have waived in previous quarters.  The increase is a result of our business growing throughout 2020, and we are excited to share the benefits of our growth and scale with clients.  We believe that market permitting, that there is a very good chance we cross into the next tier of the program (which starts at $200 million) sometime in 2021.  

CAP is subject to renewal by March 31st of each year which lines up with the deadline to file our annual ADV update.  We have received a lot of positive feedback about CAP from both current and prospective clients, and are excited to be renewing the program through March 31st, 2022.

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Review of 2020

“It was the best of times, it was the worst of times.”  ~Charles Dickens, A Tale of Two Cities

Speaking strictly from an investor’s and market perspective, the Dickens quote pretty much sums up 2020.  The year was historic for its extremes, as the panic in March related to shutdowns turned into an (almost) everything rally that ran into year-end.  It sounds strange and perverse to say, but one could argue the market may have been stronger by year-end than it would have been if there was no pandemic at all.  

Many investors felt they needed to accurately forecast the pandemic to then forecast the economy and inform their investment decisions.  We did not hold that belief nor did we make bold predictions on the pandemic, but practically every belief we had about the pandemic itself was wrong.  Fortunately, accurately predicting the pandemic was not a pre-requisite for investment success in 2020.  We thought the thing that mattered most to markets was that the pandemic would end, one way or another, and enough liquidity was available for companies to cross the chasm.  We also thought there would be winners and losers, the so-called “K” shape recovery pundits talk about.

“Everybody has a plan until they get punched in the mouth.”  ~Mike Tyson

In finance and investing, plans are necessary but not usually sufficient.  When investors are on the receiving end of a punch to the mouth, plans may need to change or evolve.  The quality of a decision made in that environment may be more dependent on how one handles pressure than how one planned.

As we do a post-mortem on 2020, we think how an investor behaved in the late February to early April period tended to make or break their year.  It certainly did for us.  March punched us, and practically everyone else, right in the mouth.  Fear was pervasive and the situation was evolving rapidly.  One thing we knew was that our clients would remember the way we behaved during the panic.  Did we keep them informed?  Did we do the job they hired us to do on their behalf?

We treated clients the way we would want to be treated.  We proactively engaged in candid communications and had ongoing dialogue.  During these conversations, we assessed potential changes to their risk tolerance, changes to their personal situation, and assessed their specific cash flow needs.  

Furthermore, we sought to minimize what has come to be known as “The Behavior Gap”.  This is the difference between how markets do and how investors do, and that gap is often the result of giving in to fear or greed at the wrong time.  In our short history as a firm, we have consistently reminded clients that the right investment strategy for them is the one that they can stick with; both in good markets and in bad ones.  It is easier to stick with a strategy in a good market, though some get tempted to increase their risk, while the real test comes in a bad one.  During the February to April period, we were happy to see our clients stay the course.  

In the midst of the panic, we could have held off rebalancing client accounts, sold positions we had questions about (and not recycled the proceeds into a new position), or raised excess cash in client accounts more generally.  We could have positioned any of those decisions as being made in an “abundance of caution”, and it is unlikely that anyone would have had much push back.  At the time, it may have even seemed like the right business decision, and who would have questioned an “abundance of caution” in any context back in March?  

That said, we did not believe that approach to be the right investment decision.  Since our clients hire us to make investment decisions on their behalf, that was our focus.  The investment decision, in our view, was to make sure we were positioned for a recovery, because when it could start to be priced in, we thought it would, and that could happen quite suddenly.  We felt that if we waited for perfect information or for the world to look less dangerous, we would have missed it.  Things were changing rapidly, so we prioritized speed and decisiveness over precision and perfection.  We knew we would make some mistakes, and we did, but we were also cognizant that the perfect could become the enemy of the good.  

March was the most difficult month we have ever encountered.  It was exhausting and we have never worked harder.  It was a period where knowing what you owned, why you owned it, and under what circumstances that could change was paramount.  If you did not do your own homework, you may not have done very well on the test.  While we wish we could have a decision or two back, and there were lessons we learned, we consider the totality of it to be some of our finest work.

"...when people are afraid, they are afraid. Confidence comes back one at a time. But fear is instantaneous." ~ Warren Buffett

We thought it would take time for investors to believe in the recovery, particularly those that were the most scared in March.  While we were proactive in our client communications during this period, the general tone was calm.  As we got into the summer, an odd trend developed; we started getting calls from clients suspicious of the swift turnaround which inspired our blog post titled “The Wall of Worry”.  We thought (and still think) that the hardest part of participating in the recovery was (and is) not fighting it.  

Observations as we head into 2021

As we think about 2021, we remind readers that no one could have predicted how 2020 would turn out.  There is a saying, “those who live by the crystal ball learn to eat ground glass.”  With that said, we approach 2021 with humility and make a few observations that we hope can pass for an outlook.  

We would expect a return to some semblance of normalcy in 2021.  As we write this, roughly 4 million COVID-19 vaccine doses have been administered in the United States.  That is a small percentage of the US population, but multiple vaccines with >90% efficacy were brought to market in about 9 months and that is a triumph of American ingenuity.  While it will take some time, we think it should allow for a more normal existence.  

Most recessions are kicked off by excesses in the private sector and are accompanied by the accumulation of too much private sector debt.  In this instance, it is the public debt that has exploded.  The American consumer, responsible for about 70% of US GDP, has a much-improved balance sheet.  

The level of government intervention is unprecedented, ongoing, and appears open-ended.  We note the incoming Treasury Secretary is the former Chairperson of the Federal Reserve, so we would expect a bias towards stimulative action on the part of the US government and the Fed.

Rational and Irrational Exuberance

In the market, we see both rational and irrational exuberance.  We would note that valuations are higher, but in a lot of instances justifiable.  We think many companies will see growth return and improved margin profiles due to cost cuts they made to weather the pandemic.  To put it another way, revenues could bounce back faster than expenses.  The future for corporate America seems pretty bright from here.  

We see silos of foolishness, but they do not seem to be a pervasive problem for the broader market.  There are a number of pre-revenue companies that we consider to be more ideas than businesses that have astonishingly high valuations.  There are others that we consider real businesses, with real revenues that are growing fast, but have revenue multiples in excess of 30x.  It used to be that a company trading for 10x revenue was considered expensive, while today some investors may consider it cheap.  Some of the optimism may be justified, given various growth and margin assumptions, but at those valuations there is little margin for error.  There are some things going on that we consider crazy, but it could get crazier.  Crazy multiplied by two is still just crazy.  

There are parts of the market where there is less exuberance, but that is usually for good reason.  The companies not participating in the exuberance come with some combination of more uncertainty, lower business quality, more cyclicality, and balance sheet risk.  To the extent something changes, or is inaccurate, that could present an opportunity and we are always on the lookout for opportunities.  

Most of the time companies and investors are complaining about the market’s short-termism.   2020 changed a lot of things, including investor time horizons.  Today many investors are complaining about the market’s long-termism.  We think there is always something to complain about and this is kind of funny if you stop to think about it.  

Accretive’s Portfolios

Our portfolios had a good year, and we are happy with our results.  Asset allocation strategies behaved well, and our individual equity strategies exceeded our expectations.  We expect to have quarterly performance reports uploaded to client portals over the coming weeks and clients can evaluate the outcomes for themselves.  

As we head into 2021, we expect to be addressing some housekeeping items in portfolios so clients should expect to see some activity early in the year.  That could come in the form of some rebalancing, trimming some positions, unwinding loss-harvesting done at year-end, and perhaps a position change or two. As always, any questions are welcomed.  

Concluding Thoughts

Reflecting on 2020 is challenging for us, as it comes with deeply conflicting emotions.  Our business grew very well and as investors, we consider 2020 to be our best work.  However, this all happened amidst great pain and suffering.  We feel good about where our business is at this point, but we are deeply saddened by the state of the world.  We hope to keep growing our business in 2021, and we anticipate that we will, but we would much rather have the world recover.  

A lot of our growth in 2020 was the result of clients telling a friend or family member about us.  We view that as one of the best compliments we can receive.  Eric, Steve, and I thank those of you who complimented us in this way, it is much appreciated.  

To our clients, we appreciate the trust and confidence you have in us. If you have any questions or concerns, please do not hesitate to contact us. To our friends, if there is anything we can do to help you, please reach out to us. We would welcome hearing from you.

Sincerely,

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Gary C. Ribe, CFA, CFP®

Chief Investment Officer, Managing Partner

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Email the author: gary@accretivewealthpartners.com

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