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VOLUME XI, NUMBER 2 I JULY, 2004 Kochis Fitz Wealth Management Commentary PAGE 1
Volume XI Number 3 | October 2004
PERFORMANCE RESULTS
(pg 9) Anticipation!
Carly Simon of course didn’t have these last three months of investment performance in mind, but
Articles she nailed its tone.
Medicare’s Recent The overall small net negative results mask a
Rx: A Prescription high degree of market volatility since the end of
for Change – At age 65 June, with prices down, then up, then down, up,
our clients enter the and down again as the quarter ended.
Medicare landscape, a
completely different Even these monthly results hide the unsettling
health insurance system
shorter-term movements, displayed here on a
from the pre-age 65
choices...(pg 2) daily basis for the S&P 500.
529 Rebalancing – These inconclusive results reflect, we believe,
What’s with all the trades the tug of war between the positive factors of
in my college savings good (though perhaps slightly slowing)
account? In September,
Kochis Fitz completed the
economic growth and corporate earnings,
second part of our annual capable Federal Reserve management of
portfolio rebalancing monetary policy, and still tame inflation arrayed
initiative, this time against the disappointing pace of job creation,
making changes to spiking oil prices, uncertainty about the election,
Section 529 college
savings plan account. (pg
frustration and even anger about the conduct of
4) the war and reconstruction in Iraq, and the
mounting terrorist violence as the US and Iraqi
Manager Watch: elections approach. The negative influences,
Fixed Income overall, won this quarter – but not by much – as
Investments – A US investors awaited greater economic and
Versatile Player on geopolitical clarity.
the Portfolio Stage – Oil Prices and Interest Rates
Most of our investment
consultation with clients
focus on the many Among the market’s greatest concerns recently
diverse opportunities has been the price of oil. Destabilized supplies
presented by equity in Iraq and Nigeria combined with hurricanes
(ownership) investments. threatening the US gulf coast to move the price
(pg 6)
to $50/barrel more than once this past quarter.
There is some evidence that hedge funds,
finding profits scarce in the flat stock market,
are now active in the international oil market, explaining some of the upward price pressure. While
our absolute return funds of funds choices have produced only modest returns this year, and we
applaud their efforts to seek additional opportunity for our clients wherever they can find it, we don’t
believe that the volume of any of that activity could be responsible for simultaneously diminishing
clients’ stock market returns. In any event, the $50/barrel price is mostly a psychological
benchmark; adjusted for inflation, it’s far less than the price spikes of the oil shocks of the 1970’s;
moreover, the US economy is far less dependent on oil now than it was then. Appropriately, then,
the investment market’s response has been relatively tame.
Since our last Commentary, the Federal Reserve has increased short-term interest rates by two,
quarter-point raises. The stock markets took these long anticipated increases in stride. Somewhat
surprisingly, as short rates have increased this year, longer term rates declined (and long bonds
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VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 2
values increased) as the bond market drew greater Medicare’s Recent Rx: A Prescription For
confidence that inflation would remain under control (the Change
annual rate of change for the CPI through August was only
2.1%). At age 65, our clients enter the Medicare landscape, a
completely different health insurance system from the pre-
We expect that the Fed has more small increases in short age 65 choices. Besides getting the “Original Medicare
rates in store this year, but it’s not clear that the same Package”---Parts A and B described below---participants
impact on long rates will occur. We’d still caution clients to now receive a new prescription drug coverage, established
avoid fixed income maturities beyond the 5 – 7 year by the Medicare Prescription Drug, Improvement and
intermediate terms we use for client’s durable fixed income Modernization Act of 2003.
positions (See the article on fixed income investing, below).
Here are some of the decisions our clients 65 or over now
Perception/Reality Mismatches face or will face soon.
Symptomatic of the general market indecision is the Overview. Original Medicare is a limited insurance
discrepancy between many commentators…and many program that covers everyone over age 64. Its Part A,
clients’…perceptions of the state of the economy and provided at government expense, is hospitalization
market and the hard statistics, probably the biggest gap coverage. Part B is voluntary medical insurance which
we’ve seen in several decades. Partisan electoral “spins”, currently costs participants $66.00 per month. To
in both directions, probably explain much of this. On the supplement Medicare, our clients may belong to a retiree
fundamentals, however, we are encouraged by solid health plan or will want to buy a private Medicare-
growth in Gross Domestic Product (3.3% annual rate for approved “Medigap” plan. There are ten versions (A
the 2nd quarter, 4% expected for the 3rd and 4.3% for the through J) of Medigap, offered by many insurers. For
year as a whole). Corporate profits are strong, but useful information about Parts A and B, and about
unavoidably coming off the huge rates of increase shown Medigap, see www.CalMedicare.org.
over the past year.
Until now, Medicare participants wanting prescription drug
Moreover, in contrast to the gloomy tone of most coverage bought one of the Medigap policies. Beginning
commentary on the domestic stock market this quarter, on 1/1/2006, Medicare offers the chance to buy a
some overseas markets have been turning in quite Prescription Drug Plan (Medicare Part D) and promotes
respectable returns, especially in the emerging markets. that new plan by prohibiting the Medigap plans from
The emerging markets index is up 8.3% for the quarter, for offering any new policies with prescription coverage after
a year-to-date return of 7.4%, after a dismal 2nd quarter. 2005. Between 2004 and the end of 2005, as an interim
measure, participants can buy a Medicare Drug Discount
Jobs present the most difficult set of statistics to fathom Card from an approved vendor (any old non-Medicare
and are an impassioned issue in this political season. The drug cards can concurrently be in service but not for the
pace of new job creation is far slower than history same purchase). The Medicare Drug Cards are described
suggests should occur in a growing economy. As we go to at www.medicare.gov in a document called The Facts
press, the Labor Department is about to announce new about Upcoming New Benefits in Medicare.
data (October 8) for September. More than 150,000 new
jobs are expected, but with no change in the Decisions. The choices for people who will be 65 after
unemployment rate of 5.4%. Historically, this rate would 1/1/06 are slightly simpler than for those already 65 before
have been considered exceptionally good and, even today, that date.
would be cause for huge celebration in many countries in
Western Europe. If you reach age 65 after 1/1/2006, you should
affirmatively sign up for Medicare Parts A (hospital) and B
Part of our “problem” is that we can remember a recent (medical) and D (drugs) around your birthday. You will
time when the job picture, as measured by the then have six months to sign up for one of two basic
unemployment rate, appeared even better. Nevertheless, choices: a Medigap policy (A through J) or Medicare Part
when one considers the more than 14% growth in C - a cheaper policy called Medicare Advantage with
productivity since 2000, the current degree of employment limited HMO and PPO plans. Alternatively, you can retain
can be considered far superior because better positioned your employer-provided retiree health insurance, if any (it’s
for longer term prosperity. How that improvement has not a Medicare-approved plan). With the advent of
been or will be distributed – who are the winners; who the Medicare Part D, none of the Medicare-approved private
losers – is where political perspective may come into play. policies can have prescription drug coverage as noted
We don’t go there. But as managers of our clients’ wealth, above. Employer-provided retiree insurance can cover
we, of course, do expect our clients’ investments to do drugs, and anything else!
better rather than worse as a result of that prosperity.
Each type of private policy (Medigap, Medicare Advantage,
Tim Kochis, Editor employer-provided) has pros and cons including different
levels of services and premiums. It’s important to sign up
for a private policy within six months of getting Part B (or
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VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 3
soon after retiree health coverage terminates) so you The scope of formulary (the list of covered drugs) is a
qualify for unrestricted coverage; late sign-up makes it difficult comparison; if the drug list approved by the
probable that the private insurer will deny coverage. You program is limited, then you will find yourself paying out-of-
are allowed to change from one Medicare-approved pocket or taking perhaps less desirable substitute drugs.
insurer/policy around your birthday each year, but the
change can’t involve getting more coverage, just changing If the formularies are identical between Part D and
to a different insurer or getting the same or less coverage. Medigap and cover all of your prescribed pharmaceuticals,
In the face of these limitations on your ability to change the then we can compare strictly on cost coverage.
coverage, we recommend beginning by taking more
coverage, rather than less. Participant Out of Pocket Costs
Annual (Including Deductibles)
If you are already age 65 or are turning 65 before the Covered Sample Medigap
end of 2005, your decisions will start with Parts A and B, Drug Needs Part D Plan “J”
$1,000 $ 437.50 $ 625.00
and will have the Medigap six-month deadline described
2,500 1,000.00 1,375.00
above. The big difference is the drug coverage. First, 5,000 2,170.00 2,625.00
your Medigap policy can have prescription coverage--- 10,000 2,420.00 7,000.00
such coverage is in versions H, I and J of the 10 available
sub-options. You can simultaneously buy a Medicare- These differences can then be added to the respective
approved Drug Discount Card which is good until the end premiums to permit a reasonable decision about
of 2005. It’s offered by many vendors and costs about $30. appropriate protection. For clients with very large
Since vendors will offer different drugs and different prices, pharmaceutical needs, Part D will likely be the better
you should learn which card should be the most useful to choice.
you. You can look up the vendors and their offerings at
www.medicare.gov. Unfortunately, the vendors can Summary
change their offering anytime, but you are effectively
locked into the card you hold in November 2004. One of All clients who will be 65 by 1/1/06 and who have Medigap
the most interesting is a card that gives discounts on the prescription coverage will be affected by this change. We
100 drugs most used by seniors. look forward to helping you with this decision in 2005. For
those clients who will become 65 after January 1, 2006,
Besides having one of these drug cards, Californians can the decision about drug coverage will be simple: Part D is
also participate in the “Medi-Cal” drug discount: a either the only choice or the basic choice – since
surprising freebie offered to all Californians on Medicare. supplemental drug policies may be permitted. If your
This is a drug discount available at participating “Medi-Cal” employer also provides drug coverage under retiree
pharmacies (there are many) where showing the Medicare healthcare, you will probably want to retain that as well.
card gives you the drugs at close to the low price charged
to Medi-Cal patients. Linda Fitz, Sarah Bailey, and Brett Gookin
.
At 1/1/06 all existing Medicare participants will have the
choice to then join Part D to get prescription coverage
there or to keep any prescription coverage within their
Medigap policies. So, assuming that you will want to New Principals of Kochis Fitz
compare the cost of beginning to use Part D to the
incremental cost of keeping the existing Medigap
prescription coverage, we’ve laid out a format for We are very pleased to announce that two
comparing the two, assuming current prices. Note the more of our star financial planners have been
range of zero coverage under Part D, and the unlimited invited to become principals of our firm.
range of its 95% coverage for amounts above $3600. By Effective January 1, 2005, Gregory Schick and
January 1, 2006, the numbers could, of course, change: Jane Zaloudek will join the ranks of the firm’s
shareholders.
Drug Coverage
Medicare MEDIGAP Please join us in congratulating Jane and
Part D Plan “J” Greg. We are very proud of their professional
Premium: $35/month Varies accomplishments and delighted that they will
with age now be able to play an even more central role
in our services to clients.
Deductible: $250/yr $250/yr
Coverage:
$250-$2,250 of costs 75% 50%
$2,251-$3,600 of costs 0% 50%
$3,601 or more of costs 95% 50%
Scope of Formulary varies varies
Annual coverage limit unlimited $3,000
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VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 4
529 Plan Rebalancing There are no tax implications to the trades we make in
Section 529 college savings accounts, so one of the
What’s with all the trades in my college savings account? practical constraints in most rebalancing is not present
here. However, under normal circumstances, we can only
In September, Kochis Fitz completed the second part of make one asset allocation change per year under the
our annual portfolio rebalancing initiative, this time making terms of these plans.
changes to Section 529 college savings plan accounts.
We discussed the theory and practice of rebalancing Some years you may see small changes within the college
portfolios in our Q2 2004 commentary. Rebalancing savings plan as we rebalance within an asset allocation
college savings plans can be more extensive because a (selling the winners and buying the losers). Other years,
second influence is at work. Based on the age of the at these key age-based intervals, you will see bigger
college savings plan beneficiary, we may significantly changes as we work a shift of the asset allocation into the
change a portfolio’s asset allocation. portfolio.
College savings plans don’t have quite the luxury of very Brett Gookin
long time frames that many other portfolios do. Unlike a
portfolio designed to fund specific expenses for decades in
length (for example, your living expenses throughout the
remainder of your life), we invest college savings plans to
provide resources for college in 17 years, or often much
less, and then to be consumed over a period of Staff Additions
approximately four years (a little longer depending on
motivation to graduate and possible graduate school). As part of our effort to make sure we’re
providing our clients with the highest quality
As one’s time horizon decreases, the highly probable services, with depth and breadth, Lisa Cuseo
return decreases as well. This is because there are fewer has recently joined our administrative staff and
years for the high highs to offset the low lows. When you Rob Biddinger has joined our planning staff.
consider that college tuition has inflated at an average of
6% per year, achieving a rate of return even just equal to Lisa Cuseo joined us in September. A recent
the rate of tuition inflation might be a stretch. graduate of the University of California, Santa
Barbara, Lisa has held an editorial internship
Consequently, instead of “betting the farm” on beating with ABC-CLIO, a publisher of educational and
tuition inflation, we have created “age-based” asset reference products and was a production
allocations for college savings plans. As the name implies, assistant with the motivational publication
the asset allocation focuses on how old your child is and Chicken Soup for the Soul.
how many years remain between now and when tuition
payments are due. Rob Biddinger also joined us in September as
a Junior Planner. He graduated from the
Age of child 0 5 9 13 17 University of California, Davis in 2000 and
Approx yrs to comes to us with four years of experience in
college start 17 12 8 4 0 the investment industry as an associate at
Cash/short-term Bernstein Investment Research and
fixed income 0% 0% 0% 0% 10% Management. Rob will sit for the CFP
examination in the spring of 2005.
Intermed. term
Asset
fixed income 0% 10% 20% 30% 30%
Allocation We’re also very pleased to have Tim Chan
Globally rejoin our Investment Operations team after a
diversified brief career hiatus in Singapore.
equities 100% 90% 80% 70% 60%
Welcome Lisa and Rob…and welcome back
Tim!
For children younger than age five (greater than 12 years
until college) target portfolios consist of 100% globally
diversified equities. From ages five through 13, we
gradually decrease equity investments and increase
intermediate term fixed income investments so that by age
13 the portfolio is a mix of 70% globally diversified equities
and 30% intermediate term fixed income. At age 17, when
tuition payments are imminent, we add a short-term fixed
income/cash allocation and begin to shift 10% per year
from equities to cash and fixed income.
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VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 5
Year-End Planning
While it feels like the year 2004 just started, the end of the year is already just around the corner. Here is a list of
year-end transactions that we are eager to help you execute…as easily as possible, and, on time:
Retirement Plans
Retirement Plans for Self-employed – If you have self-employment income (from consulting services or corporate or
non-profit boards), you are eligible to contribute to retirement plans. If you haven’t already established a specific
retirement plan, we can help you decide what plan is appropriate for you. Most of these plans must be established
no later than December 31 even if funding can occur later.
Roth IRA Conversion – If your adjusted gross income will be less than $100,000, you probably should convert part
or all of your traditional IRA to a Roth IRA by December 31. Taxes must be paid on the conversion but subsequent
earnings and distributions are tax-free in a Roth IRA…a very good deal! We can help you decide whether this
opportunity is right for you.
Catch-up 401(k) and Deductible IRA Contributions – Individuals over age 50 and those who turn 50 during 2004 are
eligible to make “catch-up” contributions to retirement plans. The 401(k) catch-up contribution is $3,000 and the
traditional and Roth IRA catch-up contribution is $500. If you meet the eligibility requirements and haven’t already
made the 401(k) catch-up contribution, please contact your 401(k) plan administrator to make the election as soon
as possible so the extra contribution is made before the year-end. The catch-up contribution to an IRA can be
made as late as April 15, 2005.
Required Retirement Plan Distributions – Clients who turn 70 ½ this calendar year are required by law to take a first
minimum distribution from their retirement accounts. Your first required minimum distribution must be taken no later
than April 1 of the year following the calendar year in which you turn 70 ½, but it is almost always best to get this
done by December 31 of the current year so that you are not required to take two distributions in the following year.
If you are in this situation, we will be in contact with you soon to coordinate distributions.
Income Taxes
Year-end State Tax Payments – As part of our routine practice, we will forward year-to-date tax information to your
tax preparer in early December. We will also be in touch with your tax preparer about any other issues that should
be taken into consideration when preparing tax projections and determining your optimal tax payment schedule. In
addition, we will forward tax information for the full year 2004 to your tax preparer in February 2005. Please
remember to forward any 1099s, K-1s, and other tax records you receive to your tax preparer. If you changed your
tax preparer since last year and/or have not already provided us with your tax preparer’s contact information,
please do so as quickly as you can.
Charitable Contributions – Appreciated long-term capital gain assets, such as stock or mutual fund shares you’ve
owned for more than a year, are ideal assets to contribute to charities because you can deduct these assets at fair
market value without paying tax on the appreciation. If you have charitable intentions but have not yet identified the
charity you wish to benefit, you can donate securities to a charitable gift fund, like the one available at Charles
Schwab & Co., Inc. By doing this before December 31, you can secure your charitable deduction for this year and
direct the gift at a later, more convenient time.
Gifts to Family Members – The current tax law allows each person to make annual gifts of $11,000 per recipient
without gift tax. A married couple can give up to $22,000 per recipient per year, free of tax. If a recipient is in a
very low tax bracket, it may make sense to give highly appreciated investments rather than cash since the recipient
can sell the investment and may only pay 5% capital gain tax. However, a cash gift is still the best if you want to
maximize the benefits to the recipient. Many clients with young children or grandchildren may be able to give up to
$110,000 (for a married couple) to fund Section 529 Education Funding Plans. These gifts use the same $11,000
per person, per recipient annual gift tax exclusion but permit a 5-year bunching to transfer the much greater
amount.
Please contact us if we can help you plan and facilitate the execution of transactions such as these, as early as
possible, before the year comes to an end.
Young Kim and Sandi Bragar
60 Spear Street • Suite 1100 San Francisco, CA 94105-1599 • Tel (415) 394-6670 • Fax 415-394-6676
VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 6
Manager Watch Beyond immediate cash, however, things do get much
more interesting and careful management of fixed-income
positions can make a meaningful difference.
Fixed Income Investments – A Versatile
Player on the Portfolio Stage. These positions tend to occur in our clients’ portfolios for
one or more of three reasons:
Most of our investment consultations with clients focus on
the many, diverse opportunities presented by equity • To create a “bullet position” to fund a specific,
(ownership) investments. That emphasis coincides with known financial goal at a particular time in the
the strong preference clients develop for equities’ future. April 15th tax payments are a very common
superiority in expected long-term returns. Quite a few example.
clients, appropriately, have no fixed-income (debt)
investments at all in their portfolios. Still, many clients • To create a “maturity-match” to fund a longish
hold significant fixed income positions…for a variety of horizon of spending goals. Some clients want a
purposes. While we haven’t devoted much attention to laddered bond portfolio holding the funds to be
this large component of available investment choices in consumed over the next three to five years, for
these Commentaries, we do pay a lot of attention to example. Periodically, then we replenish the
optimizing these positions in specific client portfolios. ladder by carving some assets out of the equity
portfolio. During bear markets, we might delay
Almost everyone maintains some immediately available selling equities for a while, permitting the ladder to
source of liquidity…for immediate expense needs, get shorter than normal, but with a catch-up when
emergency reserves, or to have resources at the ready for equities markets improve. We had a lot of practice
opportunistic investment elsewhere. The concept of with that during the 2000-2003 era.
“immediacy” here is fairly subjective. Some clients are
uncomfortable without having many months worth of • As part of a durable component of a client’s overall
anticipated expense needs in cash in plain sight. At the long-term asset allocation designed to moderate
other extreme, some others are comfortable in alerting us the risk-return profile of the entire portfolio.
to sell invested assets to generate cash…after they’ve
already written the check. We’re quite adept at The methods of achieving these exposures could be
accommodating our clients’ preferences at any point along through individual bonds, a bond mutual fund, or a
that spectrum and our staff processes cash transfers or separate account manager, or some combination of these
otherwise facilitates client cash transactions many times vehicles. The optimal choice depends on the objective of
every day. the fixed-income portfolio component, the client’s risk
tolerance (how important is the absolute safety of
We’re of course careful to achieve the maximum return principal), the time horizon, and the costs of the respective
possible for these cash positions, using taxable or tax- approaches.
exempt funds, as appropriate for clients’ tax-exposure.
Realistically, however, there’s little opportunity for
significant yield advantage here and little penalty for failing
to get a perfect result.
PRO’s CON’s
Bond • Professional management • Interest rate risk due to constant maturity
Funds • Lower transaction costs • Management fees
• Greater diversification • Less transparency of portfolio holdings (e.g.,
• Opportunity for enhanced return through active unrecognized AMT issues)
duration management, security selection, and a • For active funds: manager turnover
larger universe of opportunity.
• Institutional trading desk
• Very good liquidity
Separate • Same as above • Same as above…and…
Account • Often high investment minimums
Managers
Individual • No sub-manager fees • Probably higher broker markups
Bonds • Inviolate principal – no maturity value risk if (commissions) on bonds – i.e. less attractive
highest quality yields
• Simplicity • Less flexible portfolio design and
• Control management
• Avoidance of AMT issues
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VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 7
Individual Bonds: A Trade Off and manage risk by using futures, options and currency
forwards. The fund will also add yield by taking a stake of
In our view, the two greatest advantages of purchasing less than 10% in high-yield funds. Its duration typically
individual bonds versus bond funds or separately ranges from 3-5 years, but recently has tightened to close
managed accounts are the complete elimination of to 2 years, reflecting a defensive position against interest
interest-rate risk (so long as the bond is held to maturity) rate risk.
and some cost savings by avoiding an extra layer of
management fees. The biggest drawbacks are generally Insurance wrappers come at a small cost and add about
higher transaction costs (especially for smaller purchases), 0.25% to the fund’s annual expense ratio. They also
lower yields resulting from a focus on only the highest cause the fund to close periodically, whenever the
quality issues to minimize credit risk, and the potential for wrappers are not available at attractive prices, as is
lost gains from active duration management and active currently the case. However, the resulting combination of
security selection to attempt to exploit the pricing capital preservation and yield is very attractive, and means
inefficiencies that do occur in the bond market. that Preservation Plus typically outperforms money market
funds.
Very Short Term Goals----Individual Bonds
The management team for Preservation Plus has been
Because the time horizon here (say less than 2 years) is running stable value funds in separate accounts for over
so short, the potential opportunity loss from forgoing active 20 years without losing principal. This particular fund has
management is smaller. Moreover, for some clients the been at the head of its class for many years, and we have
absolute safety from interest rate risk is more appealing using it since its inception. Because of the “insurance
the closer the need for the funds. wrapper” situation, Preservation Plus can only be held in
tax deferred accounts and IRAs. (DBPIX is currently
A reasonable substitute would be an ultra short-term bond closed to new investors.)
fund such as DFA One-Year Fixed Income for goals with
at least a 6-9 month time horizon. DFA Two and Five Year Global Fixed Income (DFGFX
and DFGBX)
Maturity Matches: 3 – 5 years into the future
Dimensional Fund Advisors (DFA) believes the role of
The longer the time horizon and the larger the dollar fixed income in a portfolio is to reduce volatility and
amount of the goal, the greater is the potential opportunity minimize risk so investors can focus on the much-higher
loss from forgoing active management. Building the early equity market return factors. We agree. Their philosophy
(1 – 2 years) part of the maturity match with individual and implementation of fixed income investing can be
bonds is a solid approach. However, if applied to the later summarized in the following table:
components it is likely to produce lower net total returns
for the client. Short and short/intermediate bond funds Philosophy Implementation
(and sometimes even separate accounts), combined with Longer maturity Use shorter, high quality
some initial, individual bonds often work well. instruments are riskier instruments
and returns are not
Durable Bond Positions consistently greater.
The current yield curve With a steep yield curve
Like a very long maturity match, in durable positions we is the best estimate of extend the maturity; and flat,
use some combination of very low cost, short-term, future yield curves. stay short.
short/intermediate bond funds or separate accounts (if The additional volatility Use forward contracts to
clients can meet the high required minimums) to attributable to currency hedge all non-dollar
implement allocations in client portfolios. fluctuations defeats the denominated positions at all
purpose of holding times.
fixed income securities.
When hedged, country A global, hedged fixed income
The following comments reflect our thoughts on the bond indexes have portfolio should exhibit lower
specific fixed-income funds we routinely use…and then relatively low volatility than a US-only
some comments about a very special current “bond- correlations. portfolio or an unhedged global
substitute” opportunity we have been able to use in portfolio.
several client accounts.
Dimensional’s fixed income approach is “passive” in one
Scudder Preservation Plus Income Fund (DBPIX) sense – it involves no interest rate or economic forecasting
– but is “active” in engineered implementation. Research
Preservation Plus is a “stable value” fund that holds short conducted by Eugene Fama at the University of Chicago
term bonds and uses insurance “wrappers” to preserve a suggests a shifting-maturity strategy that targets segments
stable net asset value. Wrapper agreements are contracts of the yield curve with the highest expected return can add
with financial institutions such as insurance companies value relative to a conventional indexed approach. The
and banks that are designed to offset the fluctuations in optimal maturity targets are constantly reviewed using
prices normally associated with fixed income securities. information provided in the yield curve, and transactions
The fund invests at least 65% of its assets in securities in are made if the increase in expected return exceeds the
the top four rating categories, and uses a global asset cost of making the trade. Annual portfolio turnover in
allocation strategy to attempt to enhance long-term returns excess of 100% is not unusual.
60 Spear Street • Suite 1100 San Francisco, CA 94105-1599 • Tel (415) 394-6670 • Fax 415-394-6676
VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 8
With the recent decline in the dollar, DFA’s 100% hedged the management team to add value at the margin from
approach to global investing has hurt returns vs. funds that non-traditional sectors such as high-yield and foreign
do not completely hedge their non-dollar denominated bonds.
positions. The currency impacts for our clients are enjoyed,
or suffered, through their mostly unhedged overseas Our only real concern here is the overwhelming popularity
equity positions. of PIMCO’s funds and thus their huge asset base. Assets
in the Total Return fund alone are approaching $43 billion,
As you know, we do not believe you can consistently within the overall context of the $300 billion in fixed income
successfully time the market, and we remain comfortable assets managed by PIMCO as a whole. We would expect
with DFA’s approach to fixed income investing. We their ability to maneuver in more illiquid securities, such as
believe that in the long-term, their performance in this emerging markets and high-yield, to be constrained by
asset class will be consistently above the benchmark, and size over time. Yet PIMCO’s primary investment approach
continue to use these funds for durable, intermediate fixed is governments and agencies where even at these very
income positions. high levels liquidity is not (yet) an issue, and clearly its size
gives it an edge over the competition due to the significant
Vanguard Short-Term Corporate and CA Insured resources it can devote to research. Finally, despite our
Intermediate Tax-Exempt (VFSTX and VCAIX) reservations, the fund’s performance has remained ahead
of its peers and it consistently beats its benchmark, the
Vanguard’s funds’ very low expense ratios (0.21% for Vanguard Total Bond Market Index Fund. When
Short-Term Corporate and 0.17% for CA Insured continued outstanding performance is combined with low
Intermediate) give them a big edge over their peers, expenses (in the institutional class shares), it’s hard to
especially now when short-term yields are at near-historic argue against continuing to use Total Return.
lows. Rock bottom expenses, when combined with even a
very small amount of value added from active Dreyer’s Grand Ice Cream Holdings, Inc. (DRYR)
management, make the funds hard to beat.
A rather unique investment opportunity resulted from the
In July Vanguard Short-Term Corporate modified its name June 2003 combination of Dreyer’s with the Nestlé Ice
and its strategy to reflect a shift allowing it to invest in US Cream Company. The 2003 Dreyer’s Nestlé transaction
Treasuries, agencies and mortgage-backed securities. was structured with a put option that gives Dreyer’s
This shift was likely driven by the fund’s success: with shareholders the right to put their stock to Nestlé at $83
assets at well over $12B, a broader playing field was no per share in early 2006.
doubt called for. The fund is now known as Vanguard
Short-Term Investment Grade. It is too early to say if this The result is a stock that trades much like a (Nestlé) bond,
will significantly affect the fund’s performance, but with but that retains the liquidity and transaction cost
manager (and Vanguard fixed-income chief) Bob characteristics of a stock. With the future price pegged at
Auwaerter remaining at the helm, for now we continue to $83 per share in 2006, Dreyer’s is slowly converging on
use this fund for short-term positions. For almost 20 years, this price, subject only to swings in investor expectations
Auwaerter has proven himself capable of adding value in of interest rates, not on company performance. From the
the corporate arena, and with an expected commitment of current price of $80 to the deal price of $83, we expect the
at least 50% to the corporate sector even despite the return on Dreyer’s stock to be composed of price
recent strategy shift, we don’t anticipate any dramatic appreciation of approximately 2.5% annually, with an
change in performance. additional 0.30% annually from dividends, for a total return
of about 2.80% before taxes. Given the federal tax rate of
Auwaerter also plays a role in Vanguard’s CA muni fund, only 15% on dividends and long-term capital gains, the
serving as policy head, with co-manager Ried Smith after-tax equivalent of this return is approximately 2.15%,
handling strategy and day-to-day portfolio management. better than any equivalently low risk opportunity within this
We believe there is little room for active management in brief time-frame.
the highly efficient market for insured municipals, making
the fund’s low expense ratio the key driver of its success. Kochis Fitz began using Dreyer’s stock as a bond
substitute in client portfolios in late 2003. Due to interest
PIMCO Total Return (PTTRX) rate risk, it is not an appropriate vehicle if it is likely that
the position will need to be liquidated prior to 2006.
PIMCO Total Return is an actively managed, intermediate
term, investment-grade bond fund run by Bill Gross and Note: Kochis Fitz has a corporate relationship with
his team. Gross is widely considered to be one of if not Dreyer’s to provide financial planning services for
the best bond manager in the world. The fund’s duration Dreyer’s executives. As with all such relationships, we
typically ranges from 3 to 6 years, and is currently on the consider ourselves to be “insiders” of the company
lower end of this range. and thus only transact in DRYR for any of our clients
during Dreyer’s open window periods.
PIMCO has a highly disciplined investment process that
focuses on both secular (3-5 year) and cyclical (3-12 Karen Blodgett, Tom Tracy, and Tim Kochis
month) factors. The fund’s total return approach enables
60 Spear Street • Suite 1100 San Francisco, CA 94105-1599 • Tel (415) 394-6670 • Fax 415-394-6676
VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 9
PERFORMANCE RESULTS
3 Years
3rd Quarter 12 Months Annualized
2004 to 09/30/04 to 09/30/04
Fixed Income
Short-Term Benchmark Index: Lehman Brothers 1-5 Year Gov/Corp Bond
(Taxable) Benchmark Fund: Vanguard Short-term Bond Index 1.8% 1.7% 3.7%
* DFA Two Year Global Fixed Income 1.0% 0.8% 2.9%
* Scudder Preservation Plus Income 0.8% 4.4% 4.9%
Vanguard Short-term Investment Grade 1.5% 2.2% 3.8%
Intermediate Benchmark Index: Lehman Brothers Aggregate Bond
(Taxable) Benchmark Fund: Vanguard Total Bond Market Index 3.1% 3.4% 5.1%
* DFA Five Year Global Fixed Income 2.9% 2.0% 5.3%
* PIMCO Total Return 3.3% 4.5% 6.5%
Intermediate
(Tax Free) Benchmark: Morningstar Muni CA Intermediate Category Avg. 2.9% 2.9% 4.0%
Vanguard CA Insured Intermediate Tax-Exempt 3.1% 3.2% 4.8%
Real Estate
Benchmark Index: Morgan Stanley REIT Index
Benchmark Fund: Vanguard REIT Index Fund 8.1% 24.2% 18.8%
Columbia Real Estate Equity 6.9% 24.9% 18.5%
* Prana Growth NA NA NA
Balanced
Benchmark Index: 60% Wilshire 5000 and 40% Lehman Brothers Aggregate Bond
Benchmark Fund: Vanguard Balanced Index 0.2% 10.2% 6.0%
Dodge & Cox Balanced 0.5% 15.2% 11.1%
Vanguard Asset Allocation 0.0% 12.8% 5.9%
Absolute Return
Benchmark Index: S&P Hedge Fund Index
Benchmark Fund: Rydex Sphinx -0.5% 0.6% NA
* Ironwood Partners 1.3% 9.1% 8.1%
* Lazard Alt. Strategies 0.0% 3.6% 5.9%
* Lighthouse (On-Shore) 0.5% 4.9% 6.7%
* Lighthouse (Off-Shore) 0.4% 4.2% 6.2%
* Silver Creek 1.6% 7.5% 8.2%
* Treflie (On-Shore) 0.8% 7.3% 6.3%
* Treflie (Off-Shore) 0.2% 5.5% 5.6%
* Undiscovered Managers Multi-Strategy Fund 0.2% 4.7% NA
Large Cap: Domestic
Index Benchmark Index: S&P 500
Benchmark Fund: Vanguard Index 500 -1.9% 13.7% 3.9%
Schwab 1000 -1.9% 13.5% 4.7%
Large Cap ETF (SPDR)/Index (Schwab S&P 500) -1.9% 13.5% 4.1%
* Tax Managed Index Separate Account (Parametric) Return based on individual client’s portfolio
Value Style Benchmark Index: S&P 500/BARRA Value
Benchmark Fund: Vanguard Value Index Fund 1.2% 19.6% 5.8%
Berkshire Hathaway -2.8% 20.7% 8.9%
* DFA Large Cap Value -0.3% 22.9% 10.5%
* DFA Tax Managed Marketwide Value -0.6% 22.4% 6.1%
Continued on Next Page
* Preferential Access Through Kochis Fitz
Sources: Information from sources that we believe to be reliable.
Returns are stated net of managers’ fees, but before Kochis Fitz fees.
60 Spear Street • Suite 1100 San Francisco, CA 94105-1599 • Tel (415) 394-6670 • Fax 415-394-6676
VOLUME XI, NUMBER 3 I OCTOBER, 2004 Kochis Fitz Wealth Management Commentary PAGE 10
PERFORMANCE RESULTS
3 Years
3rd Quarter 12 Months Annualized
2004 to 09/30/04 to 09/30/04
Large Cap: Developed Overseas
Growth Style Benchmark Index: MSCI EAFE Growth
Benchmark Fund: Vanguard Total International Stock Fund 0.3% 22.5% 10.4%
Artisan International -2.4% 18.0% 5.5%
Value Style Benchmark Index: MSCI EAFE Value
Benchmark Fund: Vanguard Total International Stock Fund 0.3% 22.5% 10.4%
Longleaf Partners International [Closed] -4.7% 12.2% 7.4%
Small Cap: Domestic
Blend Benchmark Index: Russell 2000
Benchmark Fund: Vanguard Small Cap Index Fund -2.3% 20.9% 14.0%
* DFA Tax Managed US Small Cap -4.0% 18.3% 14.5%
* DFA US Small Cap -4.0% 18.5% 15.6%
* DFA US Micro Cap -4.3% 19.1% 19.9%
Value Style Benchmark Index: S&P Small Cap 600/BARRA Value
Benchmark Fund: Vanguard Small Cap Value Index Fund 1.1% 27.0% 16.0%
* Laudus Rosenberg US Small Cap Institutional -2.7% 21.9% 16.7%
* DFA Tax Managed US Small Cap Value -2.2% 26.2% 18.8%
* DFA US Small Cap Value -2.2% 31.5% 23.6%
* Longleaf Partners Small Cap [Closed] -2.0% 18.2% 14.9%
Small Cap: Developed Overseas
Benchmark Fund: DFA International Small Company Portfolio -0.5% 26.5% 23.1%
* DFA International Small Company -0.5% 26.5% 23.1%
* DFA International Small Cap Value 0.3% 28.8% 27.0%
Emerging Markets
Benchmark Index: MSCI Emerging Markets Free
Benchmark Fund: Vanguard Emerging Markets Index Fund 8.0% 26.3% 24.9%
* Brookdale Global Opportunity Fund 3.5% 26.1% 21.5%
* Oppenheimer Developing Markets 10.5% 33.8% 30.1%
* SSgA Emerging Markets 8.9% 25.4% 25.1%
T. Rowe Price Emerging Markets 6.8% 26.0% 25.5%
* Preferential Access Through Kochis Fitz
Sources: Information from sources that we believe to be reliable.
Returns are stated net of managers’ fees, but before Kochis Fitz fees.
60 Spear Street • Suite 1100 San Francisco, CA 94105-1599 • Tel (415) 394-6670 • Fax 415-394-6676
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